UNITED STATES SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K

þ		ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Fiscal Year Ended December 31, 2007

o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Transition Period From                      to                     

HealthSpring, Inc.

(Exact Name of Registrant as Specified in Its Charter)

Delaware		20-1821898
(State or Other Jurisdiction of Incorporation or		(I.R.S. Employer Identification No.)
Organization)
9009 Carothers Parkway, Suite 501
Franklin, Tennessee		37067
(Address of Principal Executive Offices)		(Zip Code)

(615) 291-7000

Registrant’s telephone number, including area code

Securities registered pursuant to Section 12(b) of the Exchange Act:

Common Stock, par value $0.01 per share		New York Stock Exchange
(Title of Class)		(Name of Each Exchange on which
		Registered)

Securities registered pursuant to Section 12(g) of the Exchange Act:
None

     Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes þ     No o

     Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o     No þ

     Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ     No o

     Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

     Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer þ		Accelerated filer o		Non-accelerated filer o		Smaller reporting company o
		(Do not check if a smaller reporting company)

     Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o     No þ

     The aggregate market value of the Common Stock held by non-affiliates of the registrant, based on the closing price of these shares on the New York Stock Exchange on June 29, 2007, was approximately $915.0 million. For the purposes of this disclosure only, the registrant has included shares beneficially owned by its directors, executive officers, and beneficial owners of 10% or more of the registrant’s common stock as stock held by affiliates of the registrant, provided that such persons may disclaim such status.

     As of February 25, 2008 there were outstanding 59,807,392 shares of the registrant’s Common Stock, par value $0.01 per share.

     Portions of the registrant’s definitive Proxy Statement for the 2008 Annual Meeting of Stockholders are incorporated by reference into Part III of this Annual Report on Form 10-K.

 

 

TABLE OF CONTENTS

		Page
PART I			3
Item 1. Business			3
Item 1A. Risk Factors			19
Item 1B. Unresolved Staff Comments			31
Item 2. Properties			31
Item 3. Legal Proceedings			32
Item 4. Submission of Matters to a Vote of Security Holders			32
PART II			33
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities			33
Item 6. Selected Financial Data			34
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations			37
Item 7A. Quantitative and Qualitative Disclosures About Market Risk			58
Item 8. Financial Statements and Supplementary Data			59
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure			101
Item 9A. Controls and Procedures			101
Item 9B. Other Information			102
PART III			103
Item 10. Directors, Executive Officers and Corporate Governance			103
Item 11. Executive Compensation			103
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters			103
Item 13. Certain Relationships and Related Transactions, and Director Independence			103
Item 14. Principal Accountant Fees and Services			103
PART IV			104
Item 15. Exhibits and Financial Statement Schedules			104
Ex-10.24 Contract H5410
EX-10.30 Novation Agreement for Change of Ownership of a Medicare Prescription Drug Plan Line of Business
EX-10.31 Contract (P01307)
EX-21.1 Subsidiaries of the Registrant
EX-23.1 Consent of KPMG LLP
EX-31.1 Section 302 Certification of the CEO
EX-31.2 Section 302 Certification of the CFO
EX-32.1 Section 906 Certification of the CEO
EX-32.2 Section 906 Certification of the CFO

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

     Statements contained in this Annual Report on Form 10-K that are not historical fact are forward-looking statements that the company intends to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995. Statements that are predictive in nature, that depend on or refer to future events or conditions, or that include words such as “anticipates,” “believes,” “could,” “estimates,” “expects,” “intends,” “may,” “plans,” “potential,” “predicts,” “projects,” “should,” “will,” “would,” and similar expressions are forward-looking statements. The company cautions that forward-looking statements involve known and unknown risks, uncertainties, and other factors, including those described in “Item 1A. Risk Factors,” that may cause our actual results, performance, or achievements to, be materially different from any future results, performance, or achievements expressed or implied by the forward-looking statements. Forward-looking statements reflect our current views with respect to future events and are based on assumptions and subject to risks and uncertainties. Given these uncertainties, you should not place undue reliance on these forward-looking statements. We undertake no obligation beyond that required by law to update publicly any forward-looking statements for any reason, even if new information becomes available or other events occur in the future. You should read this report and the documents that we reference in this report and have filed as exhibits to this report completely and with the understanding that our actual future results may be materially different from what we expect.

PART I

Item 1. Business

Overview

     HealthSpring, Inc. is a managed care organization operating in the United States whose primary focus is Medicare, the federal government-sponsored health insurance program for United States citizens aged 65 and older, qualifying disabled persons, and persons suffering from end-stage renal disease. Pursuant to the Medicare program, Medicare-eligible beneficiaries may receive healthcare benefits, including prescription drugs, through a managed care health plan. Our concentration on Medicare, and the Medicare Advantage program in particular, provides us with opportunities to understand the complexities of the Medicare program, design competitive products, manage medical costs, and offer high quality healthcare benefits to Medicare beneficiaries in our service areas. Our Medicare Advantage experience also allows us to build collaborative and mutually beneficial relationships with healthcare providers, including comprehensive networks of hospitals and physicians, that are experienced in managing the healthcare needs of Medicare populations. For the year ended December 31, 2007, Medicare premiums accounted for approximately 94% of our total revenue.

     On October 1, 2007, we acquired Leon Medical Centers Health Plans, Inc. (“LMC Health Plans”), a Miami, Florida-based Medicare Advantage health maintenance organization, or HMO, with approximately 25,800 members. As part of this transaction, we also entered into an exclusive long-term provider contract with Leon Medical Centers, Inc. (“LMC”), an operator of five Medicare-only medical clinics located throughout Miami-Dade County with a ten-year history of providing medical care and services primarily to the Hispanic Medicare-eligible community in South Florida. We paid the former stockholders of LMC Health Plans $355.0 million in cash and issued and deposited 2,666,667 shares of our common stock in escrow, which shares will be released to the former stockholders of LMC Health Plans in the event LMC completes construction of two additional medical centers in accordance with an agreed time schedule. The LMC medical services agreement is for an initial term of ten years with a five-year renewal option.

     We presently operate Medicare Advantage plans in Alabama, Florida, Illinois, Mississippi, Tennessee and Texas. As of December 31, 2007, our Medicare Advantage plans had over 153,000 members.

     In 2006, we began offering prescription drug benefits in accordance with Medicare Part D to our Medicare Advantage plan members, in addition to continuing to provide other medical benefits, which we sometimes refer to as our “MA-PD” plans. We also began offering prescription drug benefits on a stand-alone basis in accordance with Medicare Part D in each of our markets. We refer to our stand-alone prescription drug plan as “stand-alone PDP” or “PDP.” We expanded our stand-alone PDP program on a national basis in 2007. As of December 31, 2007, our PDP had over 139,000 members, substantially all of which had been automatically assigned to us by the Centers for Medicare and Medicaid Services, or CMS, in connection with the CMS annual premium bid process. As of January 1, 2008, our PDP membership increased to approximately 254,000 as a result of additional auto-assignments by CMS, primarily of members in the California and New York CMS regions.

      We also utilize our infrastructure and provider networks in Alabama and Tennessee to offer commercial health plans to employer groups.

     Our corporate headquarters are located at 9009 Carothers Parkway, Suite 501, Franklin, TN 37067, and our telephone number is (615) 291-7000. Our corporate website address is www.healthspring.com. Information contained on our website is not incorporated by reference into this report and we do not intend for the information on or linked to our website to constitute part of this report. We make available our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and any amendments to those reports on our website, free of charge, to individuals interested in obtaining such reports. The reports can be accessed at our website as soon as reasonably practicable after they are electronically filed with, or furnished to, the Securities and Exchange Commission, or SEC. The public may also read and copy these materials at the SEC’s public reference room located at 100 F. Street, N.E., Washington, D.C. 20549 or on their website at http://www.sec.gov. Questions regarding the

operation of the public reference room may be directed to the SEC at 1-800-732-0330. References to “HealthSpring,” “the company,” “we,” “our,” and “us” refer to HealthSpring, Inc. together with our subsidiaries and our predecessor entities, unless the context suggests otherwise.

The Medicare Program and Medicare Advantage

     Medicare is the health insurance program for United States citizens aged 65 and older, qualifying disabled persons, and persons suffering from end-stage renal disease. Medicare is funded by the federal government and administered by CMS.

     The Medicare program, created in 1965, offers both hospital insurance, known as Medicare Part A, and medical insurance, known as Medicare Part B. In general, Medicare Part A covers hospital care and some nursing home, hospice, and home care. Although there is no monthly premium for Medicare Part A, beneficiaries are responsible for paying deductibles and co-payments. All United States citizens eligible for Medicare are automatically enrolled in Medicare Part A when they turn 65. Enrollment in Medicare Part B is voluntary. In general, Medicare Part B covers outpatient hospital care, physician services, laboratory services, durable medical equipment, and some other preventive tests and services. Beneficiaries that enroll in Medicare Part B pay a monthly premium, which was $93.50 in 2007, that is usually withheld from their Social Security checks. Medicare Part B generally pays 80% of the cost of services and beneficiaries pay the remaining 20% after the beneficiary has satisfied a deductible, which was $131.00 in 2007. To fill the gaps in traditional fee-for-service Medicare coverage, individuals often purchase Medicare supplement products, commonly known as “Medigap,” to cover deductibles, copayments, and coinsurance.

     Initially, Medicare was offered only on a fee-for-service basis. Under the Medicare fee-for-service payment system, an individual can choose any licensed physician accepting Medicare patients and use the services of any hospital, healthcare provider, or facility certified by Medicare. CMS reimburses providers if Medicare covers the service and CMS considers it “medically necessary.” There is currently no fee-for-service coverage for certain preventive services, including annual physicals and wellness visits, transportation, eyeglasses, and hearing aids.

     As an alternative to the traditional fee-for-service Medicare program, in geographic areas where a managed care plan has contracted with CMS pursuant to the Medicare Advantage program, Medicare beneficiaries may choose to receive benefits from a managed care plan. The current Medicare managed care program was established in 1997 when Congress created Medicare Part C, formerly known as Medicare+Choice and now known as Medicare Advantage. Pursuant to Medicare Part C (and, as of January 1, 2006, Medicare Part D), Medicare Advantage plans contract with CMS to provide benefits at least comparable to those offered under the traditional fee-for-service Medicare program in exchange for a fixed monthly premium payment per member from CMS. The monthly premium varies based on the county in which the member resides, as adjusted to reflect the plan members’ demographics and the plans’ risk scores as more fully described below. Individuals who elect to participate in the Medicare Advantage program typically receive greater benefits than traditional fee-for-service Medicare beneficiaries including, as in our Medicare Advantage plans, additional preventive services and vision benefits. Medicare Advantage plans typically have lower deductibles and co-payments than traditional fee-for-service Medicare, and plan members generally do not need to purchase supplemental Medigap policies. In exchange for these enhanced benefits, members are generally required to use only the services and provider network provided by the Medicare Advantage plan. Many Medicare Advantage plans have no additional monthly premiums. In some geographic areas, however, and for plans with more open access to providers, members may be required to pay a monthly premium.

     Prior to 1997, CMS reimbursed health plans participating in the Medicare program primarily on the basis of the demographic data of the plans’ members. One of CMS’s primary directives in establishing the Medicare+Choice program was to make it more attractive to managed care plans to enroll members with higher intensity illnesses. To accomplish this, CMS implemented a risk adjustment payment system for Medicare health plans in 1997 pursuant to the Balanced Budget Act of 1997, or BBA. This payment system was further modified pursuant to the Medicare, Medicaid, and SCHIP Benefits Improvement and Protection Act of 2000, or BIPA. To implement the risk adjustment payment system, CMS requires that all managed care companies capture, collect, and report the necessary diagnosis code information to CMS on a regular basis. As of 2007, CMS had fully phased in this risk adjustment payment methodology with a model that bases the total CMS reimbursement payments on various clinical and demographic factors, including hospital inpatient diagnoses, additional diagnosis data from ambulatory treatment settings, hospital outpatient department and physician visits, gender, age, and eligibility status.

The 2003 Medicare Modernization Act

     Overview. In December 2003, Congress passed the Medicare Prescription Drug, Improvement and Modernization Act, which is known as the Medicare Modernization Act, or MMA. The MMA increased the amounts payable to Medicare Advantage plans such as ours, expanded Medicare beneficiary healthcare options by, among other things, creating a transitional temporary prescription drug discount card program for 2004 and 2005, and added a Medicare Part D prescription drug benefit beginning in 2006, as further described below.

     One of the goals of the MMA was to reduce the costs of the Medicare program by increasing participation in the Medicare Advantage program. According to published studies, enrollment in Medicare Advantage plans has increased by 63% since 2005, reaching approximately 8.8 million members in January 2008. Under the MMA, Medicare Advantage plans are required to use increased payments to improve the healthcare benefits that are offered, to reduce premiums, or to strengthen provider networks. We believe the reforms started by the MMA, including in particular the increased reimbursement rates to Medicare Advantage plans, have allowed and will continue to allow Medicare Advantage plans to offer more comprehensive and attractive benefits, including better preventive care benefits, while also reducing out-of-pocket expenses for beneficiaries.

     Prescription Drug Benefit. As part of the MMA, effective January 1, 2006, every Medicare recipient was able to select a prescription drug plan through Medicare Part D. The Medicare Part D prescription drug benefit is subsidized by the federal government and is additionally supported by risk-sharing with the federal government through risk corridors designed to limit the losses and any gains of the drug plans and reinsurance for catastrophic drug costs. The government subsidy is based on the national weighted average monthly bid for this coverage, adjusted for member demographics and risk factor payments. Additional subsidies are provided for dual-eligible beneficiaries and specified low-income beneficiaries.

     The Medicare Part D benefits are available to Medicare Advantage plan enrollees as well as Medicare fee-for-service enrollees. Medicare Advantage plan enrollees can elect to participate in either our combined medical and drug products, or MA-PD, or our stand alone prescription drug plan, or PDP, while fee-for-service beneficiaries are able to purchase a PDP from a list of CMS-approved PDPs available in their area, including our PDP. Our Medicare Advantage members were automatically enrolled in our MA-PD plans as of January 1, 2006 unless they chose another provider’s prescription drug coverage or one of our other plan options without drug coverage. Any Medicare Advantage member enrolling in a stand-alone PDP, however, is automatically disenrolled from the Medicare Advantage plan altogether, thereby resuming traditional fee-for-service Medicare. Certain dual-eligible beneficiaries are automatically enrolled with approved PDPs in their region, including our PDP, as described below.

     Under the standard Part D drug coverage for 2008, beneficiaries pay a $275 annual deductible, co-insurance payments equal to 25% of the drug costs between $275 and the annual coverage limit of $2,510, and all drug costs between $2,510 and $5,726.25, which is commonly referred to as the Part D “gap.” After the beneficiary has incurred $4,050 in out-of-pocket drug expenses, 95% of the beneficiaries’ remaining out-of-pocket drug costs for that year are covered by the plan or the federal government. MA-PDs are not required to mirror these limits, but are required to provide, at a minimum, coverage that is actuarially equivalent to the standard drug coverage delineated in the MMA. The deductible, co-pay, and coverage amounts are adjusted by CMS on an annual basis. As additional incentive to enroll in a Part D prescription drug plan, CMS imposes a cumulative penalty added to a beneficiary’s monthly Part D plan premium in an amount equal to 1% of the applicable premium for each month between the date of a beneficiary’s enrollment deadline and the beneficiary’s actual enrollment. This penalty amount is passed through the plan to the government. Each Medicare Advantage organization is required to offer at least one Part D drug prescription plan as part of its benefits. We currently offer prescription drug benefits through our national PDP and through our MA-PD plans in each of our markets.

     Dual-Eligible Beneficiaries. A “dual-eligible” beneficiary is a person who is eligible for both Medicare, because of age or other qualifying status, and Medicaid, because of economic status. Health plans that serve dual-eligible beneficiaries receive higher premiums from CMS for dual-eligible members, generally because a dual-eligible member has a higher risk score corresponding to his or her higher medical costs. By managing utilization and implementing disease management programs, many Medicare Advantage plans can profitably care for dual-eligible members. Pursuant to the MMA, as of January 1, 2006, dual-eligible individuals receive their drug coverage from the Medicare program rather than the Medicaid program. The MMA provides Part D subsidies and reduced or eliminated deductibles for certain low-income beneficiaries, including dual-eligible individuals. Companies offering

stand-alone PDPs with bids at or below the CMS low income subsidy premium benchmark receive a pro-rata allocation and auto-enrollment of the dual-eligible beneficiaries within the applicable region. Substantially all of our stand-alone PDP members result from CMS’s auto-assignment of dual-eligibles. For 2008, our PDP bid was below the relevant benchmarks in 31 of the 34 CMS regions.

     Bidding Process. Although Medicare Advantage plans continue to be paid on a capitated, or per member per month, or PMPM, basis, since January 1, 2006, CMS has used a rate calculation system for Medicare Advantage plans based on a competitive bidding process that allows the federal government to share in any cost savings achieved by Medicare Advantage plans. In general, the statutory payment rate for each county, which is primarily based on CMS’s estimated per beneficiary fee-for-service expenses, is known as the “benchmark” amount, and local Medicare Advantage plans annually submit bids that reflect the costs they expect to incur in providing the base Medicare Part A and Part B benefits in their applicable service areas. If the bid is less than the benchmark for that year, Medicare will pay the plan its bid amount, adjusted based on county of residence and members’ risk scores, plus a rebate equal to 75% of the amount by which the benchmark exceeds the bid, resulting in an annual adjustment in reimbursement rates. Plans are required to use the rebate to provide beneficiaries with extra benefits, reduced cost sharing, or reduced premiums, including premiums for MA-PD and other supplemental benefits and CMS has the right to audit the use of these proceeds. The remaining 25% of the excess amount is retained in the statutory Medicare trust fund. If a Medicare Advantage plan’s bid is greater than the benchmark, the plan is required to charge a premium to enrollees equal to the difference between the bid amount and the benchmark, which has made such plans charging premiums less attractive to potential members.

     Annual Enrollment and Lock-in. Prior to the MMA, Medicare beneficiaries were permitted to enroll in a Medicare managed care plan or change plans at any point during the year. As of January 1, 2006, Medicare beneficiaries have defined enrollment periods, similar to commercial plans, in which they can select a Medicare Advantage plan, stand-alone PDP, or traditional fee-for-service Medicare. The annual enrollment period for a PDP is now from November 15 through December 31 of each year, and enrollment in Medicare Advantage plans occurs from November 15 through March 31 of the subsequent year. Enrollment on or prior to December 31 will be effective as of January 1 of the following year and enrollment on or after January 1 and within the enrollment period will be effective as of the first day of the month following the date on which the enrollment occurred. After these defined enrollment periods end, generally only persons turning 65 during the year, Medicare beneficiaries who permanently relocate to another service area, dual-eligible and institutional beneficiaries and others who qualify for special needs plans, and employer group retirees will be permitted to enroll in or change health plans during that plan year. Eligible beneficiaries who fail to timely enroll in a Part D plan are subject to the penalties described above if they later decide to enroll in a Part D plan.

Products and Services

     We currently offer Medicare health plans, including MA-only and MA-PD, in local services areas in six states. We also offer a national stand-alone PDP plan.

     Medicare Advantage Plans. Our Medicare Advantage plans cover Medicare eligible members with benefits that are at least comparable to those offered under traditional Medicare fee-for-service plans. Through our plans, we have the flexibility to offer benefits not covered under traditional fee-for-service Medicare. Our plans are designed to be attractive to seniors and offer a broad range of benefits that vary across our markets and service areas but may include, for example, mental health benefits, vision and hearing benefits, transportation services, preventive health services such as health and fitness programs, routine physicals, various health screenings, immunizations, chiropractic services, and mammograms. On January 1, 2006, we began offering prescription drug benefits in accordance with Medicare Part D to our Medicare Advantage plan members, in addition to continuing to provide other medical benefits.

     Most of our Medicare Advantage members pay no monthly premium but are subject in some cases to co-payments and deductibles, depending upon the market and benefit. Our Medicare Advantage members are required to use a primary care physician within our network of providers, except in limited cases, including emergencies, and generally must receive referrals from their primary care physician in order to see a specialist or other ancillary provider. In addition to our typical Medicare Advantage benefits, we offer several different types of special needs zero premium, zero co-payment plans, or SNPs, to dual-eligible individuals, institutions, and a chronic care plan targeting individuals with chronic conditions such as diabetes, hypertension, and hyperlipidemia in each of our markets.

     The amount of premiums we receive for each Medicare Advantage member is established by contract, although it varies according to various demographic factors, including the member’s geographic location, age, gender, and eligibility status, and is further adjusted based on the member’s risk score. During the month of December 2007, our Medicare Advantage PMPM premiums (including MA-PD) across our service areas ranged from approximately $765 to approximately $1,044. In addition to the premiums payable to us, our contracts with CMS regulate, among other matters, benefits provided, quality assurance procedures, and marketing and advertising for our Medicare Advantage and PDP products.

     National Part D Plan. In January 1, 2006, we also began offering prescription drug benefits on a stand-alone basis in accordance with Medicare Part D in each of our markets, which we expanded nationally in 2007. Under our national PDP program, members pay a monthly premium depending upon their residence in the relevant CMS region. The plan offers national in-network prescription drug coverage that is subject to limitations in certain circumstances. Our PDP uses a specific prescription drug formulary. Different out-of-pocket costs, in the form of federal subsidiaries, may apply for specified low income beneficiaries. For PDP members who do not qualify for a federal subsidy, the PDP has a $275 in-network deductible, after which the member pays 25% of the costs of prescription drugs until total drug costs reach $2,510. After exceeding this amount, the member must pay 100% of the cost of prescription drugs until out-of-pocket costs reach $4,050, at which point benefits resume and the member must again make copayments per prescription (which vary based upon the type of drug prescribed). For 2008, our national PDP bid was below the benchmark in 31 of the 34 CMS regions. Of our January 1, 2008 PDP membership of 254,000, approximately 40% reside in the five regions where we offer Medicare Advantage plans and 20% reside in California. Substantially all of our stand-alone PDP members result from CMS’s assignment of dual-eligibles.

     Commercial Products. In addition to our Medicare Advantage and stand-alone PDP products, we offer commercial managed care products and services in certain of our markets. Our commercial plans cover employer groups with medical coverage and benefits that differ from plan to plan for a set monthly premium.

     We also offer management services to independent physician associations in our Alabama, Tennessee, and Texas markets, including claims processing, provider relations, credentialing, reporting, and other general business office services.

Our Health Plans

     We operate Medicare and commercial health plans through HMO subsidiaries. Each of the HMO subsidiaries is regulated by the department of insurance, and in some cases the department of health, in each state in which it operates. In addition, we own and operate non-regulated management company subsidiaries that provide administrative and management services to the HMO subsidiaries in exchange for a percentage of the HMO subsidiaries’ revenue pursuant to management agreements and administrative services agreements. Management services provided to the HMOs include:

	§		negotiation, monitoring, and quality assurance of contracts with third party healthcare providers;
	§		medical management, credentialing, marketing, and product promotion;
	§		support services and administration;
	§		financial services; and
	§		claims processing and other general business office services.

     The following table summarizes our Medicare Advantage (including MA-PD), stand-alone PDP, and commercial plan membership as of the dates indicated:

		December 31,
		2007				2006				2005
Medicare Advantage Membership
Tennessee			50,510				46,261				42,509
Texas			36,661				34,638				29,706
Alabama			30,600				27,307				24,531
Florida(1)			25,946				—				—
Illinois			8,639				6,284				4,166
Mississippi			841				642				369
Total			153,197				115,132				101,281
Medicare Stand-Alone PDP Membership			139,212				88,753				—
Commercial Membership(2)
Tennessee			11,046				29,341				29,859
Alabama			755				2,629				11,910
Total (3)			11,801				31,970				41,769

Tennessee

     We began operations in Tennessee in September 2000 when we purchased a 50% interest in an HMO in the Nashville, Tennessee area that offered commercial and Medicare products. When we purchased the plan, it had approximately 8,000 Medicare Advantage members in five counties and 22,000 commercial members in 27 counties. We purchased an additional 35% interest in the HMO in 2003 and purchased the remaining 15% interest in March 2005. Our Tennessee market is primarily divided into three major service areas including Nashville/Middle Tennessee, the three-county greater Memphis area, and the seven-county greater Chattanooga area.

     As of December 31, 2007, our Tennessee HMO, known as HealthSpring of Tennessee, had approximately 61,500 members in 31 counties, including approximately 50,500 Medicare Advantage members, and 11,000 commercial members. For 2008, in selected middle-Tennessee counties, we began offering tiered network products providing Medicare Advantage members the option of joining a “preferred” network of highly organized primary care physicians and offering enhanced benefits or a “non-preferred” network with reduced benefits and a monthly premium. This network tiering has resulted in a slight, but expected, reduction in our Medicare Advantage membership in Tennessee.

     As a result of non-renewals by several large employers, total commercial membership as of January 1, 2008 was 2,341. In addition, through Signature Health Alliance, our wholly-owned PPO network subsidiary, we provided access to our provider networks for approximately 51,000 members as of December 31, 2007, throughout the 20-county area of Middle Tennessee.

     Based upon the number of members, we believe we operate the largest Medicare Advantage health plan in the State of Tennessee. We believe the primary competing Medicare Advantage plans in our service areas in Tennessee are Windsor Health Group, Humana, Inc., UnitedHealth Group, and Blue Cross Blue Shield of Tennessee.

Texas

     We began operations in Texas in November 2000 as an independent physician association management company. We began operating an HMO in Texas in November 2002 when we acquired approximately 7,800 Medicare lives from a managed care plan in state receivership.

     As of December 31, 2007, our Texas HMO, known as Texas HealthSpring, had approximately 36,600 Medicare Advantage members in 25 counties. Our Texas market is primarily divided into three major service areas, including the 14-county greater Houston area, an eight-county area northeast of Houston, and a three-county area in the Rio Grande Valley.

     Our primary competitors in our Texas service areas include traditional Medicare Advantage and private fee-for-service, or PFFS, plans operated by Humana, Inc., Universal American Financial Corp., UnitedHealth Group, Universal Health Care, Inc., and XL Health.

Alabama

     We began operations in Alabama in November 2002 when we purchased an HMO with approximately 23,000 commercial members and approximately 2,800 Medicare members in two counties. As of December 31, 2007, our Alabama HMO, known as HealthSpring of Alabama, served over 31,000 members, including approximately 30,600 Medicare Advantage members and 755 commercial members in 33 counties. We reduced our Medicare Advantage service areas in Alabama to 21 counties as of January 1, 2008, which resulted in a slight decline in Medicare Advantage membership. As we generally operate statewide, we do not have distinct primary service areas in Alabama.

     We discontinued offering commercial benefits to new individuals and small group employers in Alabama in 2006 and as of January 1, 2008, there were approximately 1,100 commercial members participating in our individual and small employer group plans in Alabama. Pursuant to Alabama and federal law, as a result of our decision to exit the individual and small group commercial markets, we may not reenter the individual and small group employer commercial markets in Alabama until late 2010.

     Based upon the number of members, we believe we operate the second largest Medicare Advantage health plan in Alabama as of December 2007. Our primary competitors are UnitedHealth Group, Viva Health, a member of the University of Alabama at Birmingham Health System, Blue Cross Blue Shield of Alabama, and Humana, Inc.

Florida

     On October 1, 2007, we completed our acquisition of LMC Health Plans. As of December 31, 2007, LMC Health Plans had approximately 26,000 members. As part of the transaction, we entered into an exclusive long-term provider contract with LMC, which operates five Medicare-only medical clinics located in Miami-Dade County and has a ten-year history of providing medical care and customer service to the Hispanic community of South Florida. Services offered in the medical clinics include primary care, specialty-care, dental, vision, radiology, and pharmacy services as well as transportation for members to and from the clinics.

     LMC Health Plans’ primary competitors in Miami-Dade County include Humana, Inc., Care Plus, Inc. (an affiliate of Humana), Preferred Care Partners, Inc., Medica Health Plans, Inc. and Avmed, Inc.

Illinois

     We began operations in Illinois in December 2004 and, as of December 31, 2007, our Medicare Advantage plan in Illinois, known as HealthSpring of Illinois, served approximately 8,600 members in five counties in the Chicago area. We believe our primary competitors in this area are Humana, Inc., Wellcare Health Plans, Inc., Aetna, Inc. and UnitedHealth Group.

Mississippi

     We commenced our enrollment efforts in July 2005 for our Medicare Advantage plan, known as HealthSpring of Mississippi, in two counties in Northern Mississippi located near Memphis, Tennessee. We entered these service areas consistent with our growth strategy to leverage existing operations to expand to new service areas located near or contiguous to our existing service areas. In 2006, we expanded our operations in our Mississippi market to include six counties in Southern Mississippi located near Mobile, Alabama. Effective January 1, 2008, we expanded our operations into three additional counties in Southern Mississippi. Currently, we believe Humana, Inc. is the only other managed care company offering a competing Medicare Advantage plan in the State of Mississippi.

Medical Health Services Management and Provider Networks

     One of our primary goals is to arrange for high quality healthcare for our members. To achieve our goal of ensuring high quality, cost-effective healthcare, we have established various quality management programs. Our health services quality management programs integrate disease management and utilization management programs into one overall program to better coordinate the care of Medicare populations.

     We have implemented case management programs to provide more efficient and effective use of healthcare services by our members. These programs are designed to improve outcomes for members with chronic conditions through standardization, active medical management, coordinating fragmented healthcare systems to reduce healthcare duplication, providing “gate-keeping” services and improving collaboration with physicians. We utilize on-site critical care intensivists, hospitalists, and concurrent review nurses, who manage the transitions to outpatient care, hospitalization, rehabilitation, or home care. We have personnel that monitor hospitalizations, coordinate care, and ensure timely discharge from the hospital. Our chronic care program focuses on care management and treatment of our members with specific high risk or chronic conditions such as coronary artery disease, congestive heart failure, end stage renal disease, diabetes, asthma related conditions, and certain other conditions. We also offer prenatal case management programs as part of our commercial plans.

     We have information technology systems that support our quality improvement and management activities by allowing us to identify opportunities to improve care and track the outcomes of the services provided to achieve those improvements. We utilize this information as part of our monthly analytical reviews and to enhance our preventive care and disease and case management programs where appropriate.

     Additionally, we internally monitor and evaluate, and seek to enhance, the performance of our providers. Our related programs include:

	•		review of utilization of preventive measures and disease/case management resources and related outcomes;
	•		member satisfaction surveys;
	•		patient safety initiatives;
	•		integration with pharmacy services;
	•		review of grievances and appeals by members and providers;
	•		orientation visits to, and site audits of, select providers;
	•		ongoing provider and member education programs; and
	•		medical record audits.

     As more fully described below under “— Provider Arrangements and Payment Methods,” our reimbursement methods are also designed to encourage providers to utilize preventive care and our other disease and case management services in an effort to improve clinical outcomes.

     We believe strong provider relationships are essential to increasing our membership and improving the quality of care to our members on a cost efficient basis. We have established comprehensive networks of providers in each of the areas we serve. We seek providers who have experience in managing the Medicare population, including through a risk-sharing or other relationship with a Medicare Advantage plan. Our goal is to create mutually beneficial and collaborative arrangements with our providers. We believe provider incentive arrangements should not only help us attract providers, but also help align their interests with our objective of providing high-quality, cost-effective healthcare and ultimately encourage providers to deliver a level of care that promotes member wellness, reduces avoidable catastrophic outcomes, and improves clinical results.

     In some markets, we have entered into semi-exclusive arrangements with provider organizations or networks. For example, in Texas we have partnered with Renaissance Physician Organization, or RPO, a large group of 13 independent physician associations with over 1,200 physicians, including approximately 500 primary care physicians, or PCPs, and approximately 28,400 enrolled members located primarily in seven counties in the State of Texas. In Florida, pursuant to our exclusive arrangement with LMC, LMC provides primary care services (including preventive and wellness care, dental, and vision) at its five medical centers and arranges for specialty and in-patient care for all of our 25,000+ members in Miami-Dade County.

     We strive to be the preferred Medicare Advantage partner for providers in each market we serve. In addition to risk-sharing and other incentive-based financial arrangements, we seek to promote a provider-friendly relationship by paying claims promptly, providing periodic performance and efficiency evaluations, providing convenient, web-based access to eligibility data and other information, and encouraging provider input on plan benefits. We also emphasize quality assurance and compliance by periodically reviewing our networks and providers. By fostering a collaborative, interactive relationship with our providers, we are better able to gather data relevant to improving the level of preventive healthcare available under our plans, monitor the utilization of medical treatment and the accuracy of patient encounter data, risk coding and the risk scores of our plans, and otherwise ensure our contracted providers are providing high-quality and timely medical care.

     The following table shows the number of physicians, specialists, and other providers participating in our Medicare Advantage networks as of December 31, 2007:

										Specialists
		Primary Care								and Other
Market		Physicians				Hospitals				Providers
Tennessee			1,219				57				3,460
Texas			916				58				1,752
Alabama			725				51				2,390
Illinois			410				20				1,463
Mississippi			99				2				204
Florida			47				6				312
Total			3,416				194				9,581

     In our efforts to improve the quality and cost-effectiveness of healthcare for our members, we continue to refine and develop new methods of medical management and physician engagement. Two such initiatives are currently underway. We have had encouraging preliminary results from the initial pilot of our “pay-for-quality” initiative, which provides quality and outcomes-based financial incentives to physicians. The program includes an in-office practice coordinator, usually a nurse, in the physician practice that is dedicated to serving our members. We also provide a dedicated call center resource for disease management support. The program currently includes 27 sites, 348 physicians, and 25,000 members with plans in place to expand to a total of 35-40 sites, more than 400 physicians, and more than 40,000 members by the end of the year.

     In December 2006, we opened our first LivingWell Health Center clinic in Middle Tennessee dedicated to our Medicare plan members and contracted with a medical group in Tennessee that experienced encouraging pay-for-quality results as discussed above. The clinic was designed with the Medicare member in mind, with amenities designed to minimize barriers to patient access such as single floors (no elevators or stairs); adjacent parking or valet service, and, in some cases, pick up and return services; open reception areas; on-site nutritionists, dieticians, and nurse educators; wide corridors and doors; handicapped-accessible facilities; and electronic medical records. We believe our clinics improve member satisfaction, service levels, and clinical outcomes and provide for a more satisfying and cost-efficient manner for the physician to deliver care. The results of the first full year of operations of our first center support this belief, demonstrating comparative improvements in each of those areas. Based on this preliminary success, we opened our second LivingWell Health Center in Mobile in October 2007. We continue to believe and see evidence that the unique solution and experience created through LivingWell Health Centers will give us an advantage over our competitors not offering clinics, creating a more attractive network for our members.

     Generally, we contract for pharmacy services through an unrelated pharmacy benefits manager, or PBM, who is reimbursed at a discount to the “average wholesale price” for the provision of covered outpatient drugs. Our HMOs are entitled to share in drug manufacturers’ rebates based on pharmacy utilization relating to certain qualifying medications. We also contract with a third party behavioral health vendor who provides mental health and substance abuse services for our members.

Provider Arrangements and Payment Methods

     We attempt to structure our provider arrangements and payment methods in a manner that encourages the medical provider to deliver high quality medical care to our members. We also attempt to structure our provider contracts in a way that mitigates some or all of our medical risk either through capitation or other risk-sharing arrangements. In general, there are two types of medical risk — professional and institutional. Professional risk

primarily relates to physician and other outpatient services. Institutional risk primarily relates to hospitalization and other inpatient or institutionally-based services. We believe our incentive and risk-sharing arrangements help to align the interests of the physician with us and our members and improve both clinical and financial outcomes.

     We generally pay our providers under one of three payment methods:

	•		fee-for-service, based on a negotiated fixed-fee schedule where we are fully responsible for managing institutional and professional risk;
	•		capitation, based on a PMPM payment, where physicians generally assume the professional risk, or on a case-rate or per diem basis, where a hospital or health system generally assumes the institutional or professional risk, or both; and
	•		risk-sharing arrangements, typically with a physician group, where we advance, on a PMPM basis, amounts designed to cover the anticipated professional risk and then adjust payments, on a monthly basis, between us and the physician group based on actual experience measured against pre-determined sharing ratios.

     Under any of these payment methods, we may also supplement provider payments with incentive arrangements based, in general, on the quality of healthcare delivery. For example, as an incentive to encourage our providers to deliver high quality care for their patients and assist us with our quality assurance and medical management programs, we often seek to implement incentive arrangements whereby we compensate our providers for “quality performance,” including increased fee-for-service rates for specified preventive health services and additional payments for providing specified encounter data on a timely basis. We also seek to implement financial incentives relating to other operational matters where appropriate.

     In connection with the recently completed acquisition of LMC Health Plans, LMC Health Plans and LMC, our exclusive clinic model provider in South Florida, entered into a long-term medical services agreement under which we agree to pay LMC in advance for medical services at agreed-upon rates for each service multiplied by the number of plan members as of the first day of each month. There is also a risk-sharing arrangement with LMC, whereby we annually adjust such payments based on our annual institutional and professional medical loss ratio, or MLR, for LMC Health Plan members. We have agreed to share equally with LMC any surplus or deficit of up to 5% with regard to agreed-upon MLR benchmarks, which are initially set at 80.0% and increase to 81.0% during the term of this agreement.

     In a limited number of cases, we may be at risk for medical expenses above and beyond a negotiated amount (a so-called “stop loss” provision), which amount is typically calculated by reference to a percentage of billed charges, in some cases back to the first dollar of medical expense. When our members receive services for which we are responsible from a provider with whom we have not contracted, such as in the case of emergency room services from non-contracted hospitals, we generally attempt to negotiate a rate with that provider. In the case of a Medicare patient who is admitted to a non-contracting hospital, we are only obligated to pay the amount that the hospital would have received from CMS under traditional fee-for-service Medicare. In non-Medicare cases, we may be obligated to pay the full rate billed by the provider.

Sales and Marketing Programs

     Medicare Advantage enrollment is generally a decision made individually by the member. Accordingly, our sales agents and representatives focus their efforts on in-person contacts with potential enrollees as well as telephonic and group selling venues. To date, we have not actively marketed our PDP and have relied primarily on auto-assignments of dual-eligibles by CMS. As of December 31, 2007, our sales force consisted of approximately 600 appointed third party agents and 100 internal licensed sales employees (including in-house telemarketing personnel). Our third party agents are compensated on a commission basis.

     In addition to traditional marketing methods including direct mail, telemarketing, radio, television, internet and other mass media, and cooperative advertising with participating hospitals and medical groups to generate leads, we also conduct community outreach programs in churches and community centers and in coordination with government agencies. We regularly participate in local community health fairs and events, and seek to become involved with local senior citizen organizations to promote our products and the benefits of preventive care.

     Our sales and marketing programs include an integrated multimedia advertising campaign featuring Major League Baseball Hall of Fame member Willie Mays, our national spokesperson. Campaigns are tailored to each of our local service areas and are designed with the goal of educating, attracting, and retaining members and providers. In addition, we seek to create ethnically and culturally competent marketing programs where appropriate that reflect the diversity of the areas that we serve.

     Our marketing and sales activities are regulated by CMS and other governmental agencies. In testimony before Congress, CMS has stated that it is considering a range of options to further regulate the marketing of Medicare Advantage plans. In 2007, legislation was proposed in both the United States House of Representatives and Senate that would standardize marketing requirements for Medicare Advantage plans and PDPs. CMS has oversight over all, and in some cases has imposed advance approval requirements with respect to, marketing materials used by our Medicare Advantage plans, and our sales activities are limited to activities such as conveying information regarding benefits, describing the operations of managed care plans, and providing information about eligibility requirements. The activities of our third-party brokers and agents are also heavily regulated. We maintain active and ongoing training and oversight of all employed and contracted sales representatives, agents, and brokers.

     Medicare beneficiaries have a limited annual enrollment period during which they can choose between a Medicare Advantage plan and traditional fee-for-service Medicare. After this annual enrollment period ends, generally only seniors turning 65 during the year, dual-eligible and institutional beneficiaries and others who qualify for special needs plans, Medicare beneficiaries permanently relocating to another service area, and employer group retirees will be permitted to enroll in or change health plans. The annual enrollment period is from November 15 through December 31 each year for stand-alone PDPs and through March 31 of the following year for Medicare Advantage plans. Medicare Advantage beneficiaries have an open enrollment period that runs from January 1 to March 31 of each year to make one equivalent election. We have significantly adjusted the timing and intensity of our marketing efforts to align with the limited open enrollment period.

Quality Assurance

     As part of our quality assurance program, we have implemented processes designed to ensure compliance with regulatory and accreditation standards. Our quality assurance program also consists of internal programs that credential providers and programs designed to help ensure we meet the audit standards of federal and state agencies, including CMS and the state departments of insurance, as well as applicable external accreditation standards. For example, we monitor and educate, in accordance with audit tools developed by CMS, our claims, credentialing, customer service, enrollment, health services, provider relations, contracting, and marketing departments with respect to compliance with applicable laws, regulations, and other requirements.

     Our providers must satisfy specific criteria, such as licensing, credentialing, patient access, office standards, after-hours coverage, and other factors. Our participating hospitals must also meet specific criteria, including accreditation criteria established by CMS.

Competition

     We historically engaged in business in areas where there were few or no competing Medicare Advantage plans, although we are currently operating in an increasingly competitive environment, particularly with the recent advent of PFFS plans since the passage of the MMA. Medicare PFFS plans allow their members more flexibility to select physicians than Medicare Advantage HMO plans. Our principal competitors for contracts, members, and providers vary by local service area and are principally national, regional, and local commercial managed care organizations, including PDPs, targeting Medicare recipients including, among others, UnitedHealth Group, Humana, Inc., and Universal American Financial Corp. In addition, the MMA has caused a number of other managed care organizations, some of which are already in our service areas, to decide to enter the Medicare Advantage market. Moreover, the implementation of Medicare Part D prescription drug benefits in 2006 caused national and regional pharmaceutical distributors and retailers, pharmacy benefit managers, and managed care organizations to enter our markets and provide services and benefits to the Medicare-eligible population.

     We believe the principal factors influencing a Medicare recipient’s choice among health plan options are:

	•		additional premiums, if any, payable by the beneficiary;
	•		benefits offered;

	•		location and choice of healthcare providers;
	•		quality of customer service and administrative efficiency;
	•		reputation for quality care;
	•		financial stability of the plan; and
	•		accreditation results.

     A number of these competitive elements are partially dependent upon and can be positively affected by financial resources available to a health plan. We face competition from other managed care companies that have greater financial and other resources, larger enrollments, broader ranges of products and benefits, broader geographical coverage, more established reputations in the national market and in our markets, greater market share, larger contracting scale, and lower costs. Superior benefit design, provider network, and community perception may also provide a distinct competitive advantage.

Regulation

Overview

     As a managed care organization, our operations are and will continue to be subject to pervasive federal, state, and local government regulation, which will have a broad effect on the operation of our health plans. The laws and regulations affecting our industry generally give state and federal regulatory authorities broad discretion in their exercise of supervisory, regulatory, and administrative powers. These laws and regulations are intended primarily for the benefit of the members and providers of the health plans.

     In addition, our right to obtain payment from Medicare is subject to compliance with numerous regulations and requirements, many of which are complex and evolving as a result of the MMA, and are subject to administrative discretion. Moreover, since we are contracting only with the Medicare program to provide coverage for beneficiaries of our Medicare Advantage and PDP plans, our Medicare revenues are completely dependent upon the reimbursement levels and coverage determinations in effect from time to time in the Medicare program.

     In addition, in order to operate our Medicare Advantage and PDP plans, we must obtain and maintain certificates of authority or licenses from each state in which we operate. In order to remain certified we generally must demonstrate, among other things, that we have the financial resources necessary to pay our anticipated medical care expenses and the infrastructure needed to account for our costs and otherwise meet applicable licensing requirements. Each of our health plans is also required to report quarterly on its financial performance to the appropriate regulatory agency in the state in which the health plan is licensed. Each plan also undergoes periodic reviews of our quality of care and financial status by the applicable state agencies. Accordingly, in order to remain qualified for the Medicare program, it may be necessary for our Medicare plans to make changes from time to time in their operations, personnel, and services. Although we intend for our Medicare plans to maintain certification and to continue to participate in those reimbursement programs, there can be no assurance that our Medicare plans will continue to qualify for participation.

     The MMA generally requires PDP sponsors to be licensed under state law as a risk-bearing entity eligible to offer health insurance or health benefits coverage in each state in which the sponsor wishes to offer a PDP. CMS has implemented two waiver processes, however, to allow PDP sponsors to begin operations prior to obtaining state licensure or certification in all states in which they do business, even if the state already has in place a licensing process for PDP sponsors. PDP sponsors were able to seek a “single state waiver” in such states by submitting to CMS a waiver application. We applied for and were granted, effective January 1, 2007, single state licensure waivers in 46 states that will expire December 31, 2009. A “regional plan waiver” is also available to PDP sponsors that have obtained licensure as a risk-bearing entity in at least one state in a PDP region.

Federal Regulation

     Medicare. Medicare is a federally sponsored healthcare plan for persons aged 65 and over, qualifying disabled persons, and persons suffering from end-stage renal disease which provides a variety of hospital and medical insurance benefits. We contract with CMS to provide services to Medicare beneficiaries pursuant to the

Medicare program. As a result, we are subject to extensive federal regulations, some of which are described in more detail elsewhere in this report. CMS may, and does, audit any health plan operating under a Medicare contract to determine the plan’s compliance with federal regulations and contractual obligations.

     Additionally, the marketing activities of Medicare plans are strictly regulated by CMS. For example, CMS has oversight over all, and in some cases has imposed advance approval requirements with respect to, marketing materials used by our Medicare plans, and our sales activities are limited to activities such as conveying information regarding benefits, describing the operations of managed care plans, and providing information about eligibility requirements. Federal law precludes states from imposing additional marketing restrictions on Medicare plans. States, however, remain free to regulate, and typically do regulate, the marketing activities of plans that enroll commercial beneficiaries. In 2007, legislation was proposed in both the United States House of Representatives and Senate that would standardize marketing requirements for Medicare Advantage plans and PDPs. The pending legislation would prohibit various marketing activities, including cross-selling non-Medicare and Medicare products, up-selling from PDP to Medicare Advantage plans, and certain types of telemarketing and monetary rebates as inducement for enrollment. In testimony before Congress in February 2008, CMS stated that it is considering a range of options to further regulate the marketing of Medicare Advantage plans, including prohibiting “cold calls” to beneficiaries and in-home sales to beneficiaries.

     Fraud and Abuse Laws. The federal anti-kickback statute imposes criminal and civil penalties for paying or receiving remuneration (which includes kickbacks, bribes, and rebates) in connection with any federal healthcare program, including the Medicare program. The law and related regulations have been interpreted to prohibit the payment, solicitation, offering or receipt of any form of remuneration in return for the referral of federal healthcare program patients or any item or service that is reimbursed, in whole or in part, by any federal healthcare program. In some of our markets, states have adopted similar anti-kickback provisions, which apply regardless of the source of reimbursement.

     With respect to the federal anti-kickback statute, there are two safe harbors addressing certain risk-sharing arrangements. In addition, the Office of the Inspector General has adopted other safe harbors related to managed care arrangements. These safe harbors describe relationships and activities that are deemed not to violate the federal anti-kickback statute. Failure to satisfy each criterion of an applicable safe harbor does not mean that an arrangement constitutes a violation of the law; rather the arrangement must be analyzed on the basis of its specific facts and circumstances. Business arrangements that do not fall within a safe harbor create a risk of increased scrutiny by government enforcement authorities. We have attempted to structure our risk-sharing arrangements with providers, the incentives offered by our health plans to Medicare beneficiaries, and the discounts our plans receive from contracting healthcare providers to satisfy the requirements of these safe harbors. There can be no assurance, however, that upon review regulatory authorities will determine that our arrangements satisfy the requirements of the safe harbors and do not violate the federal anti-kickback statute.

     CMS has promulgated regulations that prohibit health plans with Medicare contracts from including any direct or indirect payment to physicians or other providers as an inducement to reduce or limit medically necessary services to a Medicare beneficiary. These regulations impose disclosure and other requirements relating to physician incentive plans including bonuses or withholdings that could result in a physician being at “substantial financial risk” as defined in Medicare regulations. Our ability to maintain compliance with these regulations depends, in part, on our receipt of timely and accurate information from our providers. We conduct our operations in an attempt to comply with these regulations; however, we are subject to future audit and review. It is possible that regulatory authorities may challenge our provider arrangements and operations and there can be no assurance that we would prevail if challenged.

     Federal False Claims Act. We are subject to a number of laws that regulate the presentation of false claims or the submission of false information to the federal government. For example, the federal False Claims Act provides, in part, that the federal government may bring a lawsuit against any person or entity who it believes has knowingly presented, or caused to be presented, a false or fraudulent request for payment from the federal government, or who has made a false statement or used a false record to get a claim approved. The federal government has taken the position that claims presented in violation of the federal anti-kickback statute may be considered a violation of the federal False Claims Act. Violations of the False Claims Act are punishable by treble damages and penalties of up to $11,000 per false claim. In addition to suits filed by the government, a special provision under the False Claims Act allows a private person (for example, a “whistleblower” such as a disgruntled former employee, competitor, or patient) to bring an action under the False Claims Act on behalf of the government alleging that an entity has defrauded the federal government and permits the private person to share in any settlement or judgment that may result from that lawsuit. Although we strive to operate our business in compliance with all applicable rules and regulations, we may be subject to investigations and lawsuits under the False Claims Act that may be initiated either by the government or a whistleblower. It is not possible to predict the impact such actions may have on our business.

     A number of states, including states in which we operate, have adopted false claims acts, as well as their own laws whereby a private party may file a civil lawsuit in state court.

     Health Insurance Portability and Accountability Act of 1996. The Health Insurance Portability and Accountability Act of 1996, or HIPAA, imposes requirements relating to a variety of issues that affect our business, including the privacy and security of medical information, limits on exclusions based on preexisting conditions for our plans, guaranteed renewability of healthcare coverage for most employers and individuals and administrative simplification procedures involving the standardization of transactions and the establishment of uniform healthcare provider, payor, and employer identifiers. Various federal agencies have adopted regulations to implement certain sections of HIPAA.

     For example, the Department of Health and Human Services, or DHHS, adopted a final rule that establishes the standard data content and format for the electronic submission of claims and other administrative health transactions. HIPAA also requires that each provider receive and use a national provider identifier. Although we believe our operations are compliant with the electronic data standards established by the final rule, to the extent that we are unable to support unique identifiers and electronic healthcare claims and payment transactions in compliance with these standards, we may be subject to penalties and our operations may be adversely impacted. Additionally, DHHS has adopted a final privacy rule and final security standards that apply to individually identifiable health information. The primary purposes of the privacy rule are to protect and enhance the rights of consumers by providing them access to their health information and controlling the inappropriate use of that information, and to improve the efficiency and effectiveness of healthcare delivery by creating a national framework for health privacy protection that builds on efforts by states, health systems, individual organizations, and individuals. The final rule for security standards establishes minimum standards for the security of individually identifiable health information that is transmitted or maintained electronically. We will conduct our operations in an attempt to comply with the requirements of the privacy rule and the security standards. There can be no assurance, however, that upon review regulatory authorities will find that we are in compliance with these requirements.

     On January 8, 2001, the U.S. Department of Labor’s Pension and Welfare Benefits Administration, the IRS and DHHS adopted two regulations that provide guidance on the nondiscrimination provisions under HIPAA as they relate to health factors and wellness programs. These provisions prohibit a group health plan or group health insurance issuer from denying an individual eligibility for benefits or charging an individual a higher premium based on a health factor. These regulations have not had a material adverse effect on our business.

     Employee Retirement Income Security Act of 1974. The provision of services to certain employee health benefit plans is subject to the Employee Retirement Income Security Act of 1974, or ERISA. ERISA regulates certain aspects of the relationships between plans and employers who maintain employee benefit plans subject to ERISA. Some of our administrative services and other activities may also be subject to regulation under ERISA.

     The U.S. Department of Labor adopted federal regulations that establish claims procedures for employee benefit plans under ERISA. The regulations shorten the time allowed for health and disability plans to respond to claims and appeals, establish requirements for plan responses to appeals, and expand required disclosures to participants and beneficiaries. These regulations have not had a material adverse effect on our business.

State Regulation

     Though generally governed by federal law, each of our HMO subsidiaries is licensed in the markets in which it operates and is subject to the rules, regulations, and oversight by the applicable state department of insurance in the areas of licensing and solvency. Our HMO subsidiaries file reports with these state agencies describing their capital structure, ownership, financial condition, certain inter-company transactions and business operations. Our HMO subsidiaries are also generally required to demonstrate among other things, that we have an adequate provider network, that our systems are capable of processing providers’ claims in a timely fashion and of collecting and analyzing the information needed to manage their business. State regulations also require the prior approval or notice of acquisitions or similar transactions involving an HMO, and of certain transactions between an HMO and its parent or affiliated entities or persons, such as the payment of dividends.

     Our HMO subsidiaries are required to maintain minimum levels of statutory capital. The minimum statutory capital requirements differ by state and are generally based on a percentage of annualized premium revenue, a percentage of annualized healthcare costs, or risk-based capital, or RBC, requirements. The RBC requirements are based on guidelines established by the National Association of Insurance Commissioners, or NAIC, and are administered by the states. If adopted, the RBC requirements may be modified as each state legislature deems appropriate for that state. Currently, only our Texas HMO subsidiary is subject to statutory RBC requirements and our other HMO subsidiaries are subject to other minimum statutory capital requirements mandated by the states in which they are licensed. These requirements assess the capital adequacy of an HMO subsidiary

based upon investment asset risks, insurance risks, interest rate risks and other risks associated with its business to determine the amount of statutory capital believed to be required to support the HMO’s business. If the HMO’s statutory capital level falls below certain required capital levels, the HMO may be required to submit a capital corrective plan to the state department of insurance, and at certain levels may be subjected to regulatory orders, including regulatory control through rehabilitation or liquidation proceedings.

Technology

     We have developed and implemented information technology solutions that we believe are critical to our success and our goal to provide high quality healthcare for our members. Our systems collect and process information centrally and support our core administrative functions, including premium billing, claims processing, utilization management, reporting, medical cost trending, planning and analysis, as well as certain member and provider service functions, including enrollment, member eligibility verification, claims status inquiries, and referrals and authorizations. We continue to enhance our disease and case management software functionality. We also have introduced and continue to expand electronic medical records to enhance the quality of care.

     We augment our own technology services through independent third parties, with whom we have entered into what we believe are customary agreements for the provision of software and related consulting services with respect to our information technology systems. In 2007, we consolidated multiple, independent financial systems onto a single PeopleSoft Financials platform. We also began the migration of most of the company to a new telephony and call center platform that will increase call center functionality, allowing for virtualized enterprise capability and redundancy. Substantial progress was made in 2007 with the deployment of an internal data warehousing and reporting offering that will support enterprise data mining and enhance our ability to rapidly respond to changing market, regulatory, and operational requirements.

     We have continued to invest in our core technology infrastructure. Construction was completed in 2007 of the company’s first in-house data centers. The primary data center resides in Nashville, Tennessee with a replicate data center in Birmingham, Alabama. We are completing installation of a fully redundant Wide Area Network across the enterprise. In early 2008, we will complete the first round of disaster recovery and business continuity deployment between the two data centers.

     We have also improved data security. We are in the process of implementing full disk encryption for laptop and desktop devices. In addition, we are deploying full encryption and forced authentication on all PDAs that house company information through Blackberry Enterprise Server rules enforcement.

Employees

     At December 31, 2007, we had approximately 1,320 employees, substantially all of whom were full-time. None of our employees are presently covered by a collective bargaining agreement. We consider relations with our employees to be good.

Service Marks

     The name “HealthSpring” is a registered service mark with the United States Patent and Trademark Office. We also have other registered service marks. Prior use of our service marks by third parties may prevent us from using our service marks in certain geographic areas. We intend to protect our service marks by appropriate legal action whenever necessary.

EXECUTIVE OFFICERS OF THE COMPANY

     The following are our executive officers and their biographies and ages as of February 22, 2008:

     Herbert A. Fritch, age 57, has served as the Chairman of the Board of Directors, President, and Chief Executive Officer of the company and its predecessor, NewQuest, LLC, since the commencement of operations in September 2000. Beginning his career in 1973 as an actuary, Mr. Fritch has over 30 years of experience in the managed healthcare business. Prior to founding NewQuest, LLC, Mr. Fritch founded and served as president of North American Medical Management, Inc., or NAMM, an independent physician association management company, from 1991 to 1999. NAMM was acquired by PhyCor, Inc., a physician practice management company, in 1995. Mr. Fritch also served as vice president of managed care for PhyCor following PhyCor’s acquisition of NAMM. Prior to NAMM, Mr. Fritch served as a regional vice president for Partners National Healthplans from 1988 to 1991, where he was responsible for the oversight of seven HMOs in the southern region. Mr. Fritch holds a B.A. in Mathematics from Carleton College. Mr. Fritch is a fellow of the Society of Actuaries and a member of the Academy of Actuaries.

     Gerald V. Coil, age 59, has served as Executive Vice President and Chief Operating Officer of the company since December 2006. Prior to joining the company, he was president of MHN, the behavioral health division of HealthNet, Inc., a publicly held managed care organization, from October 2002 to December 2006. From January 2002 to October 2002, Mr. Coil served in various capacities for Kaiser Permanente, a not-for-profit managed care organization. Prior to January 2002, Mr. Coil worked for NAMM in various capacities, including as head of its West Coast operations. Mr. Coil holds a B.S. in Sociology and Social Work from Arizona State University.

     Kevin M. McNamara, age 51, has served as Executive Vice President and Chief Financial Officer of the company since April 2005. He was also Treasurer of the company from April 2005 to February 2008. Mr. McNamara served from April 2005 to January 2006 as non-executive chairman of ProxyMed, Inc., a provider of automated healthcare business and cost containment solutions for financial, administrative and clinical transactions in the healthcare payments marketplace, and served as interim chief executive officer of ProxyMed, Inc. from December 2004 through June 2005. Mr. McNamara served as chief financial officer of HCCA International, Inc., a healthcare management and recruitment company, from October 2002 to April 2005. From November 1999 until February 2001, Mr. McNamara served as chief executive officer and a director of Private Business, Inc., a provider of electronic commerce solutions that help community banks provide accounts receivable financing to their small business customers. From 1996 to 1999, Mr. McNamara served as senior vice president and chief financial officer of Envoy Corporation, a provider of electronic transactions processing services to participants in the healthcare industry. Mr. McNamara also serves on the boards of directors of Luminex Corporation, a diagnostic and life sciences tool and consumables manufacturer, and Tyson Foods, Inc., a producer, distributor, and marketer of food products. Mr. McNamara is a certified public accountant (inactive) and holds a B.S. in Accounting from Virginia Commonwealth University and an M.B.A. from the University of Richmond.

     J. Gentry Barden, age 46, has served as Senior Vice President, General Counsel, and Secretary of the company since July 2005. From September 2003 to July 2005, Mr. Barden was a member of Brentwood Capital Advisors LLC, an investment banking firm based in Nashville, Tennessee. From September 2000 to February 2003, Mr. Barden was a managing director of McDonald Investments Inc., an investment-banking subsidiary of Cleveland, Ohio-based KeyCorp, in its Nashville office. From December 1998 to June 2000, Mr. Barden was a managing director and member of J.C. Bradford & Co., LLC, a Nashville-based investment-banking firm, and co-directed its mergers and acquisitions operations. Mr. Barden was a corporate and securities lawyer from 1986 through 1998, including with Bass, Berry & Sims PLC in Nashville, Tennessee. Mr. Barden graduated with a B.A. from The University of the South (Sewanee) and with a J.D. from the University of Texas.

     David L. Terry, Jr, age 57, has served as Senior Vice President and Chief Actuary of the company since March 2005, and served in various capacities, including Chief Actuary, for the company’s predecessor since July 2003. Prior to joining NewQuest, LLC, Mr. Terry served as senior consultant for Reden & Anders, Ltd., a healthcare consulting firm, from July 2000 to July 2003. Mr. Terry holds a B.S. in Statistics from Colorado State University and an M.S. in actuarial science from the University of Nebraska.

     Mark A. Tulloch, age 45, has served as Senior Vice President of Managed Care Operations since January 2007. Previously, he was Senior Vice President of Pharmacy Operations from July through December 2006.

Prior to joining the company, he served from March 2003 to July 2006 as senior vice president of operations for United Surgical Partners International, Inc. (“USPI”), an owner and operator of short-stay surgical facilities. Prior to March 2003, Mr. Tulloch spent seven years with OrthoLink Physicians Corporation, a subsidiary of USPI specializing in orthopaedic practice management and ancillary development. Mr. Tulloch served in various capacities for Ortholink, including as president and chief operating officer. Mr. Tulloch holds an M.B.A. from the Massey School at Belmont University, a M.Ed. from Vanderbilt University, and a B.S. from Middle Tennessee State University.

     Dirk O. Wales, M.D., age 50, was recently appointed as Senior Vice President and Chief Medical Officer of the company in February 2008. Dr. Wales had served as Chief Clinical Officer of the company since July 2007 and as Senior Medical Director of the company’s Texas health plan since February 2003. For over four years prior to joining the company, Dr. Wales served as chief medical officer of NAMM. Dr. Wales obtained an M.D. and a Psy.D. from Wright State University and a B.S. from Emory University.

Item 1A. Risk Factors

     You should consider carefully the risks and uncertainties described below, and all information contained in this report, in evaluating our company and our business. The occurrence of any of the following risks or uncertainties described below could significantly and adversely affect our business, prospects, financial condition, and operating results. In any such event, the trading price of our common stock could decline.

Risks Related to Our Industry

Reductions or Less Than Expected Increases in Funding for Medicare Programs Could Significantly Reduce Our Profitability.

     Medicare premiums, including premiums paid to our PDP, accounted for approximately 94% of our total revenue for the year ended December 31, 2007. As a consequence, our revenue and profitability are dependent on government funding levels for Medicare programs. The premium rates paid to Medicare health plans like ours are established by contract, although the rates differ depending on a combination of factors, including upper payment limits established by CMS, a member’s health profile and status, age, gender, county or region, benefit mix, member eligibility categories, and the plan’s risk scores. Some members of Congress have proposed significant cuts in payments to Medicare Advantage plans. In addition, continuing government efforts to contain healthcare related expenditures, including prescription drug costs, and other federal budgetary constraints that result in changes in the Medicare program, including with respect to funding, could lead to reductions in the amount of reimbursement, elimination of coverage for certain benefits or mandate additional benefits, and reductions in the number of persons enrolled in or eligible for Medicare, which in turn could reduce the number of beneficiaries enrolled in our health plans and our revenues and profitability.

CMS’s Risk Adjustment Payment System and Budget Neutrality Factors Make Our Revenue and Profitability Difficult to Predict and Could Result In Material Retroactive Adjustments to Our Results of Operations.

     CMS has implemented a risk adjustment payment system for Medicare health plans to improve the accuracy of payments and establish incentives for Medicare plans to enroll and treat less healthy Medicare beneficiaries. CMS’s risk adjustment model bases a portion of the total CMS reimbursement payments on various clinical and demographic factors including hospital inpatient diagnoses, diagnosis data from ambulatory treatment settings, including hospital outpatient facilities and physician visits, gender, age, and Medicaid eligibility. CMS requires that all managed care companies capture, collect, and report the necessary diagnosis code information to CMS. As part of the phase-in, during 2003, risk adjusted payments accounted for 10% of Medicare health plan payments, with the remaining 90% being reimbursed in accordance with the traditional CMS demographic rate books. The portion of risk adjusted payments was increased to 30% in 2004, 50% in 2005, 75% in 2006, and 100% in 2007. Because 100% of Medical Advantage premiums are now risk-based, it is difficult to predict with certainty our future revenue or profitability.

     In addition, CMS establishes premium payments to Medicare plans generally at the beginning of the calendar year and then adjusts premium levels on two separate occasions during the year on a retroactive basis. The first such adjustments updates the risk scores for the current year based on prior year’s dates of service. The second such adjustment is a final retroactive risk premium settlement for the prior year. As of January 2008, the Company is estimating and recording on a monthly basis both such adjustments. As a result of the variability of factors, including plan risk scores, that determine such estimations, the actual amount of CMS’s retroactive payment could be materially more or less than our estimates. Consequently, our estimate of our plans’ risk scores for any period and our accrual of premiums related thereto, may result in favorable or unfavorable adjustments to our Medicare premium revenue and, accordingly, our profitability.

     On February 22, 2008, CMS published preliminary results of a study designed to assess the degree of coding pattern differences between Medicare fee-for-service and Medicare Advantage and the extent to which any such differences could be appropriately addressed by an adjustment to risk scores. CMS’s study of risk scores for Medicare populations from 2004 through 2006 found that Medicare Advantage member risk scores increased substantially more than the risk scores for the general Medicare fee-for-service population. CMS acknowledged that this discrepancy could be explained by a number of reasons, including that beneficiaries enrolled in Medicare Advantage plans could be getting sicker faster than beneficiaries in Medicare fee-for-service. CMS’s study also tried to neutralize the impact of fee-for-service “joiners,” that were primarily new entrants to Medicare, and “leavers,” noting that high-risk decedents represented a larger component of fee-for-service than Medicare Advantage enrollees. Even focusing on “stayers” (CMS parlance for those persons who were enrolled either in the same Medicare Advantage plan or in Medicare fee-for-service during the study periods), CMS found that the overall risk scores of Medicare Advantage stayers increased more than those of fee-for-service stayers. Accordingly, CMS is considering a negative adjustment to the risk scores of enrollees, and a corresponding decrease in premiums, in Medicare Advantage plans for which the differences between a plan’s increase in risk scores and the increase in fee-for-service risk scores was two or more times the industry average. The company is in the early stages of evaluating the CMS study and its potential impact on the company’s Medicare Advantage plans and, until CMS releases more information, the company will not be able to determine whether any of its plans will be subject to a negative adjustment in premiums. CMS’s final recommendations are expected in early April 2008. If any of the company’s plans are subject to a risk score adjustment, such adjustment, depending on its size, could have an adverse impact on the affected plan’s results of the operations.

     Payments to Medicare Advantage plans are also adjusted by a “budget neutrality” factor that was implemented in 2003 by Congress and CMS to prevent health plan payments from being reduced overall while, at the same time, directing risk adjusted payments to plans with more chronically ill enrollees. In general, this adjustment favorably impacted payments to Medicare Advantage plans. In February 2006, the President signed legislation that reduced federal funding for Medicare Advantage plans by approximately $6.5 billion over five years. Among other changes, the legislation provided for an accelerated phase-out of budget neutrality for risk adjusted payments made to Medicare Advantage plans. These legislative changes have the effect of reducing payments to Medicare Advantage plans in general. Consequently, our plans’ premiums will be reduced over the phase-out period unless our risk scores increase in a manner sufficient, when considered together with inflation-related increases in rates, to offset the elimination of this adjustment. Although our plans’ risk scores have increased historically, there is no assurance that the increases will continue or, if they do, that they will be large enough to offset the elimination of this adjustment.

Our Records May Contain Inaccurate Information Regarding the Risk Adjustment Scores of Our Members, Which Could Cause Us to Overstate or Understate Our Revenue.

     We maintain claims and encounter data that support the risk adjustment scores of our members, which determine, in part, the revenue to which we are entitled for these members. This data is submitted to our HMO subsidiaries based on medical charts and diagnosis codes prepared by providers of medical care. Inaccurate coding by medical providers and inaccurate records for new members in our plans could result in inaccurate premium revenue and risk adjustment payments, which is subject to correction or update in later periods. Payments that we receive in connection with this corrected or updated information may be reflected in financial statements for periods subsequent to the period in which the revenue was earned. We may also find that our data regarding our members’ risk adjustment scores, when reconciled, requires that we refund a portion of the revenue that we received.

A Recent Federal Moratorium Could Reduce the Profitability of our SNP’s, and the Statutory Authority for SNP’s Could Expire.

     The United States Congress and President have recently enacted legislation that prohibits CMS from designating additional SNP’s and that prohibits existing SNP’s from enrolling individuals outside of the SNP’s existing geographic areas through December 31, 2009. These restrictions could adversely impact our operating results. In addition, under current law, CMS’s authority to designate SNP’s expires on December 31, 2009. Unless Congress and the President act to change this law, CMS may not be able to renew our SNP contracts after December 31, 2009. Failure to renew our SNP contracts could adversely impact our operating results.

The Medicare Prescription Drug, Improvement and Modernization Act of 2003 Made Changes to the Medicare Program That Materially Impacted Our Operations and Increased Competition for Members.

     The Medicare Prescription Drug, Improvement and Modernization Act of 2003, or MMA, substantially changed the Medicare program and modified how we operate our Medicare Advantage business. Many of these changes became effective in 2006. Although many of these changes are designed to benefit Medicare Advantage plans generally, certain provisions of the MMA increased competition, created challenges for us with respect to educating our existing and potential members about the changes, and may create other substantial and potentially adverse risks, including the following:

     Increased competition could adversely affect our enrollment and results of operations.

	•		The MMA increased reimbursement rates for Medicare Advantage plans, which we believe has increased the number of plans that participate in the Medicare program and created additional competition. In addition, as a result of Medicare Part D, a number of new competitors, such as pharmacy benefits managers and prescription drug retailers and wholesalers, have established PDPs that compete with some of our Medicare programs.
	•		Managed care companies began offering various new products beginning in 2006 pursuant to the MMA, including private fee-for-service, or PFFS plans and regional preferred provider organizations, or PPOs. Medicare PFFS plans and PPOs allow their members more flexibility in selecting providers outside of a designated network than Medicare Advantage HMOs such as ours allow, which typically require members to coordinate care through a primary care physician. The MMA has encouraged the creation of regional PPOs through various incentives, including certain risk corridors, or cost-reimbursement provisions, a stabilization fund for incentive payments, and special payments to hospitals not otherwise contracted with a Medicare Advantage plan that treat regional plan enrollees. There can be no assurance that PFFS plans and regional Medicare PPOs in our service areas will not continue to adversely affect our Medicare Advantage plans’ relative attractiveness to existing and potential Medicare members.

     The limited annual enrollment process has limited our ability to market our products.

Medicare beneficiaries generally have a limited annual enrollment period during which they can choose to participate in a Medicare Advantage plan rather than receive benefits under the traditional fee-for-service Medicare program. After the annual enrollment period, most Medicare beneficiaries are not permitted to change their Medicare benefits. The annual enrollment process and subsequent “lock-in” provisions of the MMA have restricted our growth as they have limited our ability to enter new service areas and market to or enroll new members in our established service areas outside of the annual enrollment periods.

     The competitive bidding process may adversely affect our profitability.

Payments for local and regional Medicare Advantage plans are based on a competitive bidding process that may decrease the amount of premiums paid to us or cause us to increase the benefits we offer without a corresponding increase in premiums. As a result of the competitive bidding process, in order to maintain our current level of profitability we may be, and in some limited cases have been, required to reduce benefits or charge our members an additional premium, either of which could make our health plans less attractive to members and adversely affect our membership.

We derive a significant portion of our Medicare revenue from our PDP operations, and legislative or regulatory actions, economic conditions, or other factors that adversely affect those operations could materially reduce our revenue and profits.

     We may be unable to sustain our PDP operation’s profitability over the long-term, and our failure to do so could have an adverse effect on our results of operations. Factors that could adversely affect our PDP operations include:

	•		Congress may make changes to the Medicare program, including changes to the Part D benefit. We cannot predict what these changes might include or what effect they might have on our revenue or medical expense or plans for growth.
	•		We are making actuarial assumptions about the utilization of prescription drug benefits in our MA-PD plans and our PDPs. We cannot assure you that these assumptions will prove to be correct or that premiums will be sufficient to cover the benefits provided.
	•		Substantially all of our PDP membership is the result of CMS’s auto-assignment of dual-eligible beneficiaries in regions where our Part D premium bids are below CMS benchmarks. In general, our premium bids are based on assumptions regarding PDP enrollment, utilization, drug costs, and other factors. For 2008, our bid was below the benchmark in 31 of the 34 CMS regions. Our continued participation in the Part D program is conditional on our meeting certain contractual performance standards and otherwise complying with CMS regulations governing our operating compliance. If our future Part D premium bid is not below CMS’s threshold, or if CMS determines we have not met contractual or regulatory performance standards, we risk losing PDP members who were previously assigned to us and we will not have additional PDP members auto-assigned to us.
	•		Medicare beneficiaries who are dual-eligibles generally are able to disenroll and choose another PDP at any time, and certain Medicare beneficiaries also have a limited ability to disenroll from the plan they initially select and choose a different PDP. Medicare beneficiaries who are not dually eligible will be able to change PDPs during the annual open enrollment period. We may not be able to retain the auto-assigned members or those members who affirmatively choose our PDPs, and we may not be able to attract new PDP members.
	•		In February 2007, the U.S. House of Representatives’ Committee on Oversight and Government Reform sent a letter to a number of Medicare plans requesting copies of information submitted by the

plans to CMS relating to, among other things, Part D plan profits and administrative costs; discounts, rebates, and other price concessions from drug manufacturers and pharmacies; and concessions passed through to beneficiaries. Although we did not receive a similar letter, we expect it is a precursor to hearings and further congressional investigation into Part D related profits, and perhaps into the profitability of Medicare managed care plans, generally.

Financial accounting for the Medicare Part D benefits is complex and requires difficult estimates and assumptions.

	•		The MMA provides for “risk corridors” that are designed to limit to some extent the gains or losses MA-PDs or PDPs would incur if their costs turned out to be lower or higher than those in the plans’ bids submitted to CMS. For 2006 and 2007, drug plans bore all gains and losses up to 2.5% of their expected costs, but retained 25% of the gain or were reimbursed for 25% of the loss between 2.5% and 5%, and 20% of gains and losses in excess of 5%. The company will settle with CMS on amounts related to the risk corridor adjustments and prepaid subsidies in 2008 as part of a final settlement of Part D payments for the 2007 plan year. In 2008, health plans assume a greater amount of risk pursuant to the risk corridors. In 2008, Medicare drug plans will bear all gains and losses of up to 5% of their expected costs and will retain 50% of the gains or be reimbursed 50% of the loss between 5% and 10% and will retain 20% of the gain or be reimbursed 20% of the loss in excess of 10%.
	•		The accounting and regulatory guidance regarding the proper method of accounting for Medicare Part D, particularly as it relates to the timing of revenue and expense recognition, taken together with the complexity of the Part D product and the estimates related thereto, may lead to variability in our reporting of quarter-to-quarter earnings and to uncertainty among investors and research analysts following the company as to the impacts of our Medicare Part D plans on our full year results.

Our Business Activities Are Highly Regulated and New and Proposed Government Regulation or Legislative Reforms Could Increase Our Cost of Doing Business, and Reduce Our Membership, Profitability, and Liquidity.

     Our health plans are subject to substantial federal and state regulation. These laws and regulations, along with the terms of our contracts and licenses, regulate how we do business, what services we offer, and how we interact with our members, providers, and the public. Healthcare laws and regulations are subject to frequent change and varying interpretations. Changes in existing laws or regulations, or their interpretations, or the enactment of new laws or the issuance of new regulations could adversely affect our business by, among other things:

	•		imposing additional license, registration, or capital reserve requirements;
	•		increasing our administrative and other costs;
	•		reducing the premiums we receive from CMS;
	•		forcing us to undergo a corporate restructuring;
	•		increasing mandated benefits without corresponding premium increases;
	•		limiting our ability to engage in inter-company transactions with our affiliates and subsidiaries;
	•		forcing us to restructure our relationships with providers; and
	•		requiring us to implement additional or different programs and systems.

     It is possible that future legislation and regulation and the interpretation of existing and future laws and regulations could have a material adverse effect on our ability to operate under the Medicare program and to continue to serve our members and attract new members.

If We Are Required to Maintain Higher Statutory Capital Levels for Our Existing Operations or if We Are Subject to Additional Capital Reserve Requirements as We Pursue New Business Opportunities, Our Cash Flows and Liquidity May Be Adversely Affected.

     Our health plans are operated through subsidiaries in various states. These subsidiaries are subject to state regulations that, among other things, require the maintenance of minimum levels of statutory capital, or net worth, as defined by each state. One or more of these states may raise the statutory capital level from time to time. Other states have adopted risk-based capital requirements based on guidelines adopted by the National Association of Insurance Commissioners, which tend to be, although are not necessarily, higher than existing statutory capital requirements. Currently, Texas is the only jurisdiction in which we operate that has adopted risk-based capital requirements. Regardless whether the other states in which we operate adopt risk-based capital requirements, the state departments of insurance can require our HMO subsidiaries to maintain minimum levels of statutory capital in excess of amounts required under the applicable state laws if they determine that maintaining additional statutory capital is in the best interests of our members. Any other changes in these requirements could materially increase our statutory capital requirements. In addition, as we continue to expand our plan offerings in new states or pursue new business opportunities, we may be required to maintain additional statutory capital. For example, in connection with its order approving our acquisition of LMC Health Plans, the Florida Office of Insurance Regulation has required LMC Health Plans to maintain until September 2010 at least 115% of the statutory surplus otherwise required by Florida law. In any case, our available funds could be materially reduced, which could harm our ability to implement our business strategy.

If State Regulators Do Not Approve Payments, Including Dividends and Other Distributions, by Our Health Plans to Us, Our Business and Growth Strategy Could Be Materially Impaired or We Could Be Required to Incur Additional Indebtedness to Fund These Strategies.

     Our health plan subsidiaries are subject to laws and regulations that limit the amount of dividends and distributions they can pay to us for purposes other than to pay income taxes related to the earnings of the health plans. These laws and regulations also limit the amount of management fees our health plan subsidiaries may pay to affiliates of our health plans, including our management subsidiaries, without prior approval of, or notification to, state regulators. The pre-approval and notice requirements vary from state to state with some states, such as Texas, generally allowing, subject to advance notice requirements, dividends to be declared, provided the HMO meets or exceeds the applicable deposit, net worth, and risk-based capital requirements. The discretion of the state regulators, if any, in approving a dividend is not always clearly defined. Historically, we have not relied on dividends or other distributions from our health plans to fund a material amount of our operating cash requirements. If the regulators were to deny or significantly restrict our subsidiaries’ requests to pay dividends to us or to pay management and other fees to the affiliates of our health plan subsidiaries, however, the funds available to us would be limited, which could impair our ability to implement our business and growth strategy. Alternatively, we could be required to incur additional indebtedness to fund these strategies.

Corporate Practice of Medicine and Fee-Splitting Laws May Govern Our Business Operations, and Violation of Such Laws Could Result in Penalties and Adversely Affect Our Arrangements With Contractors and Our Profitability.

     In several states, we must comply with laws known as the corporate practice of medicine laws that prohibit a business corporation from practicing medicine, employing physicians to practice medicine, or exercising control over medical treatment decisions by physicians. In these states, typically only medical professionals or a professional corporation in which the shares are held by licensed physicians or other medical professionals may provide medical care to patients. In general, health maintenance organizations are exempt from laws prohibiting the corporate practice of medicine in many states due to the integrated nature of the delivery system. Many states also have some form of fee-splitting law, prohibiting certain business arrangements that involve the splitting or sharing of medical professional fees earned by a physician or another medical professional for the delivery of healthcare services.

     In general, we perform only non-medical administrative and business services for physicians and physician groups. We do not represent that we offer medical services, and we do not exercise control over the practice of medical care by providers with whom we contract. We do, however, monitor medical services to ensure they are provided in a high quality cost effective manner and reimbursed within the appropriate scope of licensure. In addition, we have developed close relationships with our network providers that include our review and monitoring of the coding of medical services provided by those providers. We also have compensation arrangements with providers that may be based on a percentage of certain provider fees and in certain cases our network providers have agreed to exclusivity arrangements. In each case, we believe we have structured these and other arrangements on a basis that complies with applicable state law, including the corporate practice of medicine and fee-splitting laws.

     Despite our structuring these arrangements in ways that we believe comply with applicable law, regulatory authorities may assert that we are engaged in the corporate practice of medicine or that our contractual arrangements with providers constitute unlawful fee-splitting. Moreover, we cannot predict whether changes will be made to existing laws or if new ones will be enacted, which could cause us to be out of compliance with these requirements. If our arrangements are found to violate corporate practice of medicine or fee-splitting laws, our provider or independent physician association management contracts could be found legally invalid and unenforceable, which could adversely affect our operations and profitability, and we could be subject to civil or, in some cases, criminal, penalties.

We Are Required to Comply With Laws Governing the Transmission, Security and Privacy of Health Information That Require Significant Compliance Costs, and Any Failure to Comply With These Laws Could Result in Material Criminal and Civil Penalties.

     Regulations under the Health Insurance Portability and Accountability Act of 1996, or HIPAA, require us to comply with standards regarding the exchange of health information within our company and with third parties, including healthcare providers, business associates, and our members. These regulations include standards for common healthcare transactions, including claims information, plan eligibility, and payment information; unique identifiers for providers and employers; security; privacy; and enforcement. HIPAA also provides that to the extent that state laws impose stricter privacy standards than HIPAA privacy regulations, a state seeks and receives an exception from the Department of Health and Human Services regarding certain state laws, or state laws concern certain specified areas, such state standards and laws are not preempted.

     We conduct our operations in an attempt to comply with all applicable HIPAA requirements. Given the complexity of the HIPAA regulations, the possibility that the regulations may change, and the fact that the regulations are subject to changing and, at times, conflicting interpretation, our ongoing ability to comply with the HIPAA requirements is uncertain. Furthermore, a state’s ability to promulgate stricter laws, and uncertainty regarding many aspects of such state requirements, make compliance more difficult. To the extent that we are unable to support unique identifiers and electronic healthcare claims and payment transactions that comply with the electronic data transmission standards established under HIPAA, we may be subject to penalties and operations may be adversely impacted. Additionally, the costs of complying with any changes to the HIPAA regulations may have a negative impact on our operations. Sanctions for failing to comply with the HIPAA health information provisions include criminal penalties and civil sanctions, including significant monetary penalties. In addition, our failure to comply with state health information laws that may be more restrictive than the regulations issued under HIPAA could result in additional penalties.

Risks Related to Our Business

If Our Medicare Contracts Are Not Renewed or Are Terminated, Our Business Would Be Substantially Impaired.

     We provide services to our Medicare eligible members through our Medicare Advantage health plans and PDP pursuant to a limited number of contracts with CMS. These contracts generally have terms of one year and must be renewed each year. Each of our contracts with CMS is terminable for cause if we breach a material provision of the contract or violate relevant laws or regulations. If we are unable to renew, or to successfully rebid or compete for any of these contracts, or if any of these contracts are terminated, our business would be materially impaired.

Because Our Premiums, Which Generate Most of Our Revenue, Are Established by Contract and Cannot Be Modified During the Contract Terms, Our Profitability Will Likely Be Reduced or We Could Cease to Be Profitable if We Are Unable to Manage Our Medical Expenses Effectively.

     Substantially all of our revenue is generated by premiums consisting of monthly payments per member that are established by contracts with CMS for our Medicare Advantage plans and PDP or by contracts with our commercial customers, all of which are typically renewable on an annual basis. If our medical expenses exceed our estimates, except in very limited circumstances or as a result of risk score adjustments for Medicare member health acuity, we will be unable to increase the premiums we receive under these contracts during the then-current terms. As a result, our profitability depends, to a significant degree, on our ability to adequately predict and effectively manage our medical expenses related to the provision of healthcare services. Relatively small changes in our MLR can create significant changes in our financial results. Accordingly, the failure to adequately predict and control

medical expenses and to make reasonable estimates and maintain adequate accruals for incurred but not reported, or IBNR, claims, may have a material adverse effect on our financial condition, results of operations, or cash flows.

     Historically, our medical expenses as a percentage of premium revenue have fluctuated. Factors that may cause medical expenses to exceed our estimates include:

	•		an increase in the cost of healthcare services and supplies, including prescription drugs, whether as a result of inflation or otherwise;
	•		higher than expected utilization of healthcare services, particularly in-patient hospital services;
	•		periodic renegotiation of hospital, physician, and other provider contracts;
	•		changes in the demographics of our members and medical trends affecting them;
	•		new mandated benefits or other changes in healthcare laws, regulations, and practices;
	•		new treatments and technologies;
	•		consolidation of physician, hospital, and other provider groups;
	•		contractual disputes with providers, hospitals, or other service providers; and
	•		the occurrence of catastrophes, major epidemics, or acts of terrorism.

     Because of the relatively high average age of the Medicare population, medical expenses for our Medicare Advantage plans may be particularly difficult to control. We attempt to control these costs through a variety of techniques, including capitation and other risk-sharing payment methods, collaborative relationships with primary care physicians and other providers, advance approval for hospital services and referral requirements, case and disease management and quality assurance programs, preventive and wellness visits for members, information systems, and reinsurance. Despite our efforts and programs to manage our medical expenses, we may not be able to continue to manage these expenses effectively in the future. If our medical expenses increase, our profits could be reduced or we may not remain profitable.

Our Failure to Estimate IBNR Claims Accurately Would Affect Our Reported Financial Results.

     Our medical care costs include estimates of our IBNR claims. We estimate our medical expense liabilities using actuarial methods based on historical data adjusted for payment patterns, cost trends, product mix, seasonality, utilization of healthcare services, and other relevant factors. Actual conditions, however, could differ from those we assume in our estimation process. We continually review and update our estimation methods and the resulting accruals and make adjustments, if necessary, to medical expense when the criteria used to determine IBNR change and when actual claim costs are ultimately determined. As a result of the uncertainties associated with the factors used in these assumptions, the actual amount of medical expense that we incur may be materially more or less than the amount of IBNR originally estimated. If our estimates of IBNR are inadequate in the future, our reported results of operations would be negatively impacted. Further, our inability to estimate IBNR accurately may also affect our ability to take timely corrective actions, further exacerbating the extent of any adverse effect on our results.

Competition in Our Industry, Particularly New Sources of Competition Since the Implementation of Medicare Part D, May Limit Our Ability to Attract or Retain Members, Which Could Adversely Affect Our Results of Operations.

     We operate in a highly competitive environment subject to significant changes as a result of business consolidations, evolving Medicare products (including PDPs and PFFS plans), new strategic alliances, and aggressive marketing practices by other managed care organizations that compete with us for members. Our principal competitors for contracts, members, and providers vary by local service area and have traditionally been comprised of national, regional, and local managed care organizations that serve Medicare recipients, including, among others, UnitedHealth Group, Humana, Inc., and Universal American Financial Corp. In addition, we have experienced significant competition from new competitors, including pharmacy benefit managers and prescription

drug retailers and wholesalers, and our traditional managed care organization competitors whose PFFS plans and stand-alone PDPs have been attracting our Medicare Advantage and PDP members. As a result of the foregoing factors, among others, we experienced disenrollments from our plans during 2007 that were comparable to 2006 but in both years were at rates higher than we previously experienced or anticipated. Many managed care companies and other new Part D plan participants have greater financial and other resources, larger enrollments, broader ranges of products and benefits, broader geographical coverage, more established reputations in the national market and our markets, greater market share, larger contracting scale, and lower costs than us. Our failure to attract and retain members in our health plans as a result of such competition could adversely affect our results of operations.

Our Inability to Maintain Our Medicare Advantage and PDP Members or Increase Our Membership Could Adversely Affect Our Results of Operations.

     A reduction in the number of members in our Medicare Advantage and PDP plans, or the failure to increase our membership, could adversely affect our results of operations. In addition to competition, factors that could contribute to the loss of, or failure to attract and retain, members include:

	•		negative accreditation results or loss of licenses or contracts to offer Medicare Advantage plans;
	•		negative publicity and news coverage relating to us or the managed healthcare industry generally;
	•		litigation or threats of litigation against us;
	•		automatic disenrollment, whether intentional or inadvertent, as a result of members choosing a stand-alone PDP; and
	•		our inability to market to and re-enroll members who enroll with our competitors because of the new annual enrollment and lock-in provisions under the MMA.

A Disruption in Our Healthcare Provider Networks Could Have an Adverse Effect on Our Operations and Profitability.

     Our operations and profitability are dependent, in part, upon our ability to contract with healthcare providers and provider networks on favorable terms. In any particular service area, healthcare providers or provider networks could refuse to contract with us, demand higher payments, or take other actions that could result in higher healthcare costs, disruption of benefits to our members, or difficulty in meeting our regulatory or accreditation requirements. In some service areas, healthcare providers may have significant market positions. If healthcare providers refuse to contract with us, use their market position to negotiate favorable contracts, or place us at a competitive disadvantage, then our ability to market products or to be profitable in those service areas could be adversely affected. Our provider networks could also be disrupted by the financial insolvency of a large provider group. Any disruption in our provider network could result in a loss of membership or higher healthcare costs.

     Our Texas operations comprised 24% of our Medicare Advantage members and 24% of our total revenue for the year ended December 31, 2007 (assuming the revenue of LMC Health Plans had been included for all of 2007). A significant proportion of our providers in our Texas market are affiliated with RPO, a large group of independent physician associations. As of December 31, 2007, physicians associated with RPO served as the primary care physicians for approximately 77% of our members in our Texas market. Our agreements with RPO generally have a term expiring December 31, 2014, but may be terminated sooner by RPO for cause or in connection with a change in control of the company that results in the termination of senior management and otherwise raises a reasonable doubt as to our successor’s ability to perform the agreements. If our Texas HMO subsidiary’s agreement with RPO were terminated, we would be required to sign direct contracts with the RPO physicians or additional physicians in order to avoid a material disruption in care of our Houston-area members. It could take significant time to negotiate and execute direct contracts, and we would be forced to reassign members to new primary care physicians if all of the current primary care physicians did not sign direct contracts. This would result in loss of membership assuming that not all members would accept the reassignment to a new primary care physician. Accordingly, any significant disruption in, or termination of, our relationship with RPO could materially and adversely impact our results of operations. Moreover, RPO’s ability to terminate its agreements with us in connection with certain changes in control of the company could have the effect of delaying or frustrating a potential acquisition or other change in control of the company.

     As of December 31, 2007, our LMC Health Plans subsidiary comprised 17% of our Medicare Advantage membership and 18% of our total revenue for the quarter then ended. A substantial portion of the medical services provided to our LMC Health Plans' members is provided by LMC pursuant to a long-term medical services agreement. Any material breach or other material non-performance by LMC of its obligations to us under the medical services agreement could result in a significant disruption in the medical services provided to our Florida plan members, for which we would have no immediately acceptable alternative service provider, and which would adversely affect our results of operations. In addition, the medical services agreement could be terminated by LMC for cause or in connection with certain changes in control of the Florida plan.

Outsourced Service Providers May Make Mistakes and Subject Us to Financial Loss or Legal Liability.

     We outsource certain of the functions associated with the provision of managed care and management services, including claims processing related to the provision of Medicare Part D prescription drug benefits. The service providers to whom we outsource these functions could inadvertently or incorrectly adjust, revise, omit, or transmit the data with which we provide them in a manner that could create inaccuracies in our risk adjustment data, cause us to overstate or understate our revenue, cause us to authorize incorrect payment levels to members of our provider networks, or violate certain laws and regulations, such as HIPAA.

We May Be Unsuccessful in Implementing Our Growth Strategy If We Are Unable to Complete Acquisitions on Favorable Terms or Integrate the Businesses We Acquire into Our Existing Operations, or If We Are Unable to Otherwise Expand into New Service Areas in a Timely Manner in Accordance with Our Strategic Plans.

     Opportunistic acquisitions of contract rights and other health plans are an important element of our growth strategy. We may be unable to identify and complete appropriate acquisitions in a timely manner and in accordance with our or our investors’ expectations for future growth. The market price of businesses that operate Medicare Advantage plans has generally increased recently, which may increase the amount we are required to pay to complete any future acquisitions. Some of our competitors have greater financial resources than we have and may be willing to pay more for these businesses. In addition, we are generally required to obtain regulatory approval from one or more state agencies when making acquisitions, which may require a public hearing, regardless whether we already operate a plan in the state in which the business to be acquired is located. We may be unable to comply with these regulatory requirements for an acquisition in a timely manner, or at all. Moreover, some sellers may insist on selling assets that we may not want or transferring their liabilities to us as part of the sale of their companies or assets. Even if we identify suitable acquisition targets, we may be unable to complete acquisitions or obtain the necessary financing for these acquisitions on terms favorable to us, or at all.

     To the extent we complete acquisitions, we may be unable to realize the anticipated benefits from acquisitions because of operational factors or difficulties in integrating the acquisitions with our existing businesses. This may include the integration of:

	•		additional employees who are not familiar with our operations;
	•		new provider networks, which may operate on terms different from our existing networks;
	•		additional members, who may decide to transfer to other healthcare providers or health plans;
	•		disparate information technology, claims processing, and record-keeping systems; and
	•		accounting policies, including those that require a high degree of judgment or complex estimation processes, including estimates of IBNR claims, accounting for goodwill, intangible assets, stock-based compensation, and income tax matters.

     Additionally, with respect to the recently completed acquisition of LMC Health Plans, our integration and execution risks in addition to those outlined above include:

	•		our inexperience in the highly penetrated and competitive South Florida Medicare Advantage market;
	•		the ability of LMC to successfully operate and expand its medical clinics, and our ability to successfully operate and otherwise manage our anticipated growth under the terms of our long-term, exclusive, clinic-model medical services agreement with LMC; and
	•		our inexperience in the operation of a clinic-model-dependent HMO generally.

     For all of the above reasons, we may not be able to successfully implement our acquisition strategy. Furthermore, in the event of an acquisition or investment, we may issue stock that would dilute existing stock ownership and incur debt that would restrict our cash flow, as we have in the acquisition of LMC Health Plans. We may also assume liabilities, incur large and immediate write-offs,

incur unanticipated costs, divert management’s attention from our existing business, experience risks associated with entering markets in which we have no or limited prior experience, or lose key employees from the acquired entities.

Our Substantial Debt Obligations Pursuant to the New Credit Agreement Could Restrict Our Operations.

     In connection with the acquisition of LMC Health Plans, we entered into a new credit facility (the “New Credit Agreement”). Borrowings of $300.0 million under the New Credit Agreement, together with our available cash on hand, were used to fund the acquisition and expenses related thereto. As of December 31, 2007, $296.25 million of debt was outstanding under the term loan facility of the New Credit Agreement. The $100.0 million revolving credit facility under the New Credit Agreement is currently undrawn. Loans under the New Credit Agreement are secured by a first priority lien on substantially all assets of the company and its non-HMO subsidiaries, including a pledge by the company and its non-HMO subsidiaries of all of the equity interests in each of their domestic subsidiaries.

     The New Credit Agreement contains conditions precedent to extensions of credit and representations, warranties, and covenants, including financial covenants, customary for transactions of this type. Financial covenants include (i) a maximum leverage ratio comparing total indebtedness to consolidated adjusted EBITDA, (ii) minimum net worth requirements for each HMO subsidiary calculated by reference to applicable regulatory requirements, and (iii) maximum capital expenditures, in each case as more specifically provided in the New Credit Agreement.

     This significant new indebtedness could have adverse consequences on us, including:

	•		limiting our ability to compete and our flexibility in planning for, or reacting to, changes in our business and industry;
	•		increasing our vulnerability to general economic and industry conditions; and
	•		requiring a substantial portion of cash flows from operating activities to be dedicated to debt repayment, reducing our ability to use such cash flow to fund our operations, expenditures, and future business or acquisition opportunities.

     The New Credit Agreement contains customary events of default and, if we fail to comply with specified financial and operating ratios, we could be in breach of the New Credit Agreement. Any breach or default could allow our lenders to accelerate our indebtedness and terminate all commitments to extend additional credit.

     Our ability to maintain specified financial and operating ratios and operate within the contractual limitations can be affected by a number of factors, many of which are beyond our control, and we cannot assure you that we will be able satisfy them.

Negative Publicity Regarding the Managed Healthcare Industry Generally or Us in Particular Could Adversely Affect Our Results of Operations or Business.

     Negative publicity regarding the managed healthcare industry generally or us in particular may result in increased regulation and legislative review of industry practices that further increase our costs of doing business and adversely affect our results of operations by:

	•		requiring us to change our products and services;
	•		increasing the regulatory burdens under which we operate;
	•		adversely affecting our ability to market our products or services; or
	•		adversely affecting our ability to attract and retain members.

We Are Dependent Upon Our Executive Officers and the Loss of Any One or More of These Officers and Their Managed Care Expertise Could Adversely Affect Our Business.

     Our operations are highly dependent on the efforts of Herbert A. Fritch, our President and Chief Executive Officer, and certain other senior executives who have been instrumental in developing our business strategy and forging our business relationships. Although certain of our executives, including Mr. Fritch, have entered into employment agreements with us, these agreements may not provide sufficient incentives for those executives to continue their employment with us. Although we believe we could replace any executive we lose, the loss of the leadership, knowledge, and experience of Mr. Fritch and our other executive officers could adversely affect our business. Moreover, replacing one or more of our executives may be difficult or may require an extended period of time. We do not currently maintain key man insurance on any of our executive officers.

Violation of the Laws and Regulations Applicable to Us Could Expose Us to Liability, Reduce Our Revenue and Profitability, or Otherwise Adversely Affect Our Operations and Operating Results.

     The federal and state agencies administering the laws and regulations applicable to us have broad discretion to enforce them. We are subject, on an ongoing basis, to various governmental reviews, audits, and investigations to verify our compliance with our contracts, licenses, and applicable laws and regulations. An adverse review, audit, or investigation could result in any of the following:

•

loss of our right to participate in the Medicare program;

	•		loss of one or more of our licenses to act as an HMO or to otherwise provide a service;
	•		forfeiture or recoupment of amounts we have been paid pursuant to our contracts;
	•		imposition of significant civil or criminal penalties, fines, or other sanctions on us and our key employees;
	•		damage to our reputation in existing and potential markets;
	•		increased restrictions on marketing our products and services; and
	•		inability to obtain approval for future products and services, geographic expansions, or acquisitions.

     The U.S. Department of Health and Human Services Office of the Inspector General, Office of Audit Services, or OIG, is conducting a national review of Medicare Advantage plans to determine whether they used payment increases consistent with the requirements of the MMA. Under the MMA, the bidding process requires that payment increases be used to cover increased medical costs, reduce beneficiary premiums or cost sharing, enhance benefits, put additional payment amounts in a benefit stabilization fund, or stabilize or enhance access. We cannot assure you that the findings of an audit or investigation of our business would not have an adverse effect on us or require substantial modifications to our operations. In addition, private citizens, acting as whistleblowers, are entitled to bring enforcement actions under a special provision of the federal False Claims Act.

Claims Relating to Medical Malpractice and Other Litigation Could Cause Us to Incur Significant Expenses.

     From time to time, we are party to various litigation matters, some of which seek monetary damages. Managed care organizations may be sued directly for alleged negligence, including in connection with the credentialing of network providers or for alleged improper denials or delay of care. In addition, Congress and several states have considered or are considering legislation that would expressly permit managed care organizations to be held liable for negligent treatment decisions or benefits coverage determinations. Of the states in which we currently operate, only Texas has enacted legislation relating to health plan liability for negligent treatment decisions and benefits coverage determinations. In addition, our providers involved in medical care decisions may be exposed to the risk of medical malpractice claims. Some of these providers do not have malpractice insurance. Although our network providers are independent contractors, claimants sometimes allege that a managed care organization should be held responsible for alleged provider malpractice, particularly where the provider does not have malpractice insurance, and some courts have permitted that theory of liability.

     Similar to other managed care companies, we may also be subject to other claims of our members in the ordinary course of business, including claims of improper marketing practices by our independent and employee sales agents and claims arising out of decisions to deny or restrict reimbursement for services.

     We cannot predict with certainty the eventual outcome of any pending litigation or potential future litigation, and we cannot assure you that we will not incur substantial expense in defending future lawsuits or indemnifying third parties with respect to the results of such litigation. The loss of even one of these claims, if it results in a significant damage award, could have a material adverse effect on our business. In addition, our exposure to potential liability under punitive damage or other theories may significantly decrease our ability to settle these claims on reasonable terms.

     We maintain errors and omissions insurance and other insurance coverage that we believe are adequate based on industry standards. Potential liabilities may not be covered by insurance, our insurers may dispute coverage or may be unable to meet their obligations, or the amount of our insurance coverage and related reserves may be inadequate. We cannot assure you that we will be able to obtain insurance coverage in the future, or that insurance will continue to be available on a cost-effective basis, if at all. Moreover, even if claims brought against us are unsuccessful or without merit, we would have to defend ourselves against such claims. The defense of any such actions may be time-consuming and costly and may distract our management’s attention. As a result, we may incur significant expenses and may be unable to effectively operate our business.

The Inability or Failure to Properly Maintain Effective and Secure Management Information Systems, Successfully Update or Expand Processing Capability, or Develop New Capabilities to Meet Our Business Needs Could Result in Operational Disruptions and Other Adverse Consequences.

     Our business depends significantly on effective and secure information systems. The information gathered and processed by our management information systems assists us in, among other things, marketing and sales tracking, underwriting, billing, claims processing, medical management, medical care cost and utilization trending, financial and management accounting, reporting, planning and analysis and e-commerce. These systems also support on-line customer service functions, provider and member administrative functions and support tracking and extensive analyses of medical expenses and outcome data. These information systems and applications require continual maintenance, upgrading, and enhancement to meet our operational needs and handle our expansion and growth. Any inability or failure to properly maintain management information systems or related disaster recovery programs, successfully update or expand processing capability or develop new capabilities to meet our business needs in a timely manner, could result in operational disruptions, loss of existing customers, difficulty in attracting new customers or in implementing our growth strategies, disputes with customers and providers, regulatory problems, increases in administrative expenses, loss of our ability to produce timely and accurate reports, and other adverse consequences. To the extent a failure in maintaining effective information systems occurs, we may need to contract for these services with third-party management companies, which may be on less favorable terms to us and significantly disrupt our operations and information flow.

     Furthermore, our business requires the secure transmission of confidential information over public networks. Because of the confidential health information we store and transmit, security breaches could expose us to a risk of regulatory action, litigation, possible liability, and loss. Our security measures may be inadequate to prevent security breaches, and our business operations and profitability would be adversely affected by cancellation of contracts, loss of members, and potential criminal and civil sanctions if they are not prevented.

If We Are Unable to Maintain Effective Internal Controls Over Financial Reporting, Investors Could Lose Confidence in the Reliability of Our Financial Statements, Which Could Result in a Decrease in the Price of Our Common Stock.

     Because of our status as a public company, we are required to enhance and test our financial, internal, and management control systems to meet obligations imposed by the Sarbanes-Oxley Act of 2002. Our financial and management control systems include corporate governance, corporate control, internal audit, disclosure controls and procedures, and financial reporting and accounting systems. Consistent with the Sarbanes-Oxley Act and the rules and regulations of the SEC, management’s assessment of our internal controls over financial reporting and the audit opinion of the company’s independent registered accounting firm as to the effectiveness of our controls is first required in connection with our filing of this Annual Report on Form 10-K. If we are unable to maintain that we have effective internal controls over financial reporting or if our independent auditors are unable to conclude that our internal controls over financial reporting are effective, investors could lose confidence in the reliability of our financial statements, which could result in a decrease in the value of our common stock.

Anti-takeover Provisions in Our Organizational Documents and State Insurance Laws Could Make an Acquisition of Us More Difficult and May Prevent Attempts by Our Stockholders to Replace or Remove Our Current Management.

     Provisions of our amended and restated certificate of incorporation and our second amended and restated bylaws may delay or prevent an acquisition of us or a change in our management or similar change in control transaction, including transactions in which stockholders might otherwise receive a premium for their shares over then current prices or that stockholders may deem to be in their best interests. In addition, these provisions may frustrate or prevent any attempts by our stockholders to replace or remove our current management by making it more difficult for stockholders to replace members of our board of directors. Because our board of directors is responsible for appointing the members of our management team, these provisions could in turn affect any attempt by our stockholders to replace current members of our management team. These provisions provide, among other things, that:

	•		special meetings of our stockholders may be called only by the chairman of the board of directors, by our chief executive officer, or by the board of directors pursuant to a resolution adopted by a majority of the directors;
	•		any stockholder wishing to properly bring a matter before a meeting of stockholders must comply with specified procedural and advance notice requirements;
	•		actions taken by the written consent of our stockholders require the consent of the holders of at least 662/3% of our outstanding shares;
	•		our board of directors is classified into three classes, with each class serving a staggered three-year term;
	•		the authorized number of directors may be changed only by resolution of the board of directors;
	•		our second amended and restated bylaws and certain sections of our amended and restated certificate of incorporation relating to anti-takeover provisions may generally only be amended with the consent of the holders of at least 662/3% of our outstanding shares;
	•		directors may be removed other than at an annual meeting only for cause;
	•		any vacancy on the board of directors, however the vacancy occurs, may only be filled by the directors; and
	•		our board of directors has the ability to issue preferred stock without stockholder approval.

     Additionally, the insurance company laws and regulations of the jurisdictions in which we operate restrict the ability of any person to acquire control of an insurance company, including an HMO, without prior regulatory approval. Under certain of those statutes and regulations, without such approval or an exemption therefrom, no person may acquire any voting security of a domestic insurance company, including an HMO, or an insurance holding company that controls a domestic insurance company or HMO, if as a result of such transaction such person would own more than a specified percentage, such as 5% or 10%, of the total stock issued and outstanding of such insurance company or HMO, or, in some cases, more than a specified percentage of the issued and outstanding shares of an insurance holding company. HealthSpring is an insurance holding company for purposes of these statutes and regulations.

Item 1B. Unresolved Staff Comments

None.

Item 2. Properties

     We lease office space in the following locations which includes space for our corporate headquarters and for our health plans:

Location		Square footage				Expiration Date
Nashville, Tennessee			140,690			December 2010
Franklin, Tennessee			23,654			December 2014
Various Other Tennessee cities			20,298			various
Birmingham, Alabama			71,923			April 2016
Various Other Alabama cities			19,958			various
Houston, Texas			64,782			October 2010
Various Other Texas cities			6,488			various
Chicago, Illinois			10,604			December 2010
Hattiesburg, Mississippi			1,944			December 2010

     The company’s Florida HMO subsidiary currently shares office space with LMC pursuant to an office space agreement entered into as part of the company’s acquisition of the LMC Health Plans. We anticipate that our Florida operations will be relocated on or about March 15, 2008 to approximately 16,000 square feet of office space leased from an independent third party.

     We believe our facilities are adequate for our present and currently anticipated needs.

Item 3. Legal Proceedings

     We are not currently involved in any pending legal proceedings that we believe are material to our financial condition and results of operations. We are, however, involved from time to time in routine legal matters and other claims incidental to our business, including employment-related claims, claims relating to our HMO subsidiaries’ contractual relationships with providers and members, and claims relating to marketing practices of sales representatives that are employed by, or independent contractors to, our HMO subsidiaries.

Item 4. Submission of Matters to a Vote of Security Holders

     None.

PART II

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Market for Common Stock

     Our common stock is listed on the New York Stock Exchange, or NYSE, under the trading symbol “HS.”

     The following table sets forth the quarterly ranges of the high and low sales prices of the common stock on the NYSE during the calendar periods indicated.

		2007
		High				Low
First Quarter		$	24.49			$	19.03
Second Quarter			25.33				17.92
Third Quarter			20.50				15.28
Fourth Quarter			21.38				17.08

		2006
		High				Low
First Quarter (beginning February 3)		$	24.19			$	16.61
Second Quarter			19.42				15.41
Third Quarter			22.44				16.66
Fourth Quarter			22.62				17.73

     The last reported sale price of our common stock on the NYSE on February 27, 2008 was $18.78, and we had approximately 216 holders of record of our common stock on such date.

Dividends

     We have not declared or paid any cash dividends on our common stock since our organization in March 2005. We currently intend to retain any future earnings to fund the operation, development, and expansion of our business, and therefore we do not anticipate paying cash dividends in the foreseeable future. Our New Credit Agreement restricts our ability to declare cash dividends on our common stock. Our ability to pay dividends is also dependent on the availability of cash dividends from our regulated HMO subsidiaries, which are restricted by the laws of the states in which we operate, as well as the requirements of CMS relating to the operations of our Medicare health plans. Any future determination to declare and pay dividends will be at the discretion of our board of directors, subject to compliance with applicable law and the other limitations described above.

Issuer Purchases of Equity Securities

     In June 2007, the company’s board of directors authorized a stock repurchase program to repurchase up to $50.0 million of the company’s common stock over the succeeding twelve months in open market transactions or through privately negotiated transactions. The New Credit Agreement permits the company’s repurchase of up to $50.0 million in common stock, subject to certain limitations relating to minimum liquidity requirements and sources of funds for the repurchases. As of December 31, 2007, the company had not repurchased any common stock under the program. In addition, the company did not repurchase any shares of its common stock in any other transaction during the fourth quarter of 2007. As of February 27, 2008, the company had repurchased 478,500 shares of common stock during 2008 at an average price of $18.55 per share in open market transactions pursuant to the stock repurchase program.

Performance Graph

     The following graph compares the change in the cumulative total return (including the reinvestment of dividends) on the company’s common stock for the period from February 3, 2006, the date our shares of common stock began trading on the NYSE, to the change in the cumulative total return on the stocks included in the Standard & Poor’s 500 Stock Index and to a company-selected Peer Group Index over the same period. The graph assumes an investment of $100 made in our common stock at a price of $21.98 per share, the closing sale price on February 3, 2006, our first day of trading following our IPO (at $19.50 per share), and an investment in each of the other indices on February 3, 2006. We did not pay any dividends during the period reflected in the graph.

     The Peer Group Index consists of the following companies, which is a group of companies in the healthcare services industry of comparable market capitalization that we have used to assist in evaluating the competitiveness of our executive compensation plans and policies: Amerigroup Corporation, AmSurg Corp., Apria Healthcare Group Inc., Centene Corporation, Emergency Medical Services Corporation, Healthways, Inc., Lifepoint Hospitals, Inc., Magellan Health Services, Inc., Pediatrix Medical Group, Inc., Psychiatric Solutions, Inc., Sierra Health Services, Inc., Universal American Financial Corp., and WellCare Health Plans, Inc. In the Form 10-K we filed for the fiscal year ending December 31, 2006, United Surgical Partners International, Inc. was a member of our peer group, but was subsequently acquired in 2007 and is no longer publicly traded. As a result, we have deleted them from our peer group.

COMPARISON OF CUMULATIVE TOTAL RETURN
Among HealthSpring, Inc., The S&P 500 Index
And a Peer Group

				2/06					3/06					6/06					9/06					12/06					3/07					6/07					9/07					12/07
	HealthSpring, Inc				100.00					84.67					85.30					87.58					92.58					107.14					86.72					88.72					86.67
	S&P 500				100.00					101.52					100.06					105.73					112.81					113.53					120.66					123.11					119.01
	Peer Group				100.00					105.31					106.01					105.16					116.36					125.67					124.91					131.88					120.53

Item 6. Selected Financial Data

     The following tables present selected historical financial data and other information for the company and its predecessor, NewQuest, LLC. We derived the selected historical statement of income, cash flow, and balance sheet data as of and for the years ended December 31, 2003, and 2004 and for the period from January 1, 2005 to February 28, 2005 from the audited consolidated financial statements of NewQuest, LLC and as of and for the period from March 1, 2005 to December 31, 2005 and the years ended December 31, 2006, and 2007 from the audited consolidated financial statements of the company. The audited consolidated financial statements and the related notes to the audited consolidated financial statements of NewQuest, LLC and the company as of December 31, 2006 and 2007, for the combined twelve month period ended December 31, 2005, and the years ended December 31, 2006, and 2007 together with the related report of our independent registered public accounting firm are included

elsewhere in this report. We derived the selected balance sheet data as of February 28, 2005 from the unaudited consolidated financial statements of NewQuest, LLC.

     The selected consolidated financial data and other information set forth below should be read in conjunction with the consolidated financial statements included in this report and the related notes and Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

		HealthSpring, Inc.														HealthSpring,				Predecessor
		Year Ended December 31,														Inc				Year Ended December 31,
																Period from				Period from
											Combined					March 1, 2005				January 1,
											Twelve Months					to				2005 to
											Ended December					December 31,				February 28,
		2007(1)				2006					31, 2005(2)					2005(3)				2005(3)				2004(4)				2003(5)
		(dollars in thousands, except share and unit data)
Statement of Income Data:
Revenue:
Premium:
Medicare premiums		$	1,479,576			$	1,149,844				$	705,677				$	610,913			$	94,764			$	433,729			$	240,037
Commercial premiums			46,648				120,504					126,872					106,168				20,704				146,318				120,877
Total premiums			1,526,224				1,270,348					832,549					717,081				115,468				580,047				360,914
Management and other fees			24,601				26,688					20,416					16,955				3,461				17,919				11,054
Investment income			23,943				11,920					3,798					3,337				461				1,449				695
Total revenue			1,574,768				1,308,956					856,763					737,373				119,390				599,415				372,663
Operating expenses:
Medical expense:
Medicare expense			1,187,331				900,358					553,084					478,553				74,531				338,632				187,368
Commercial expense			38,662				108,168					107,095					90,783				16,312				124,743				104,164
Total medical expense			1,225,993				1,008,526					660,179					569,336				90,843				463,375				291,532
Selling, general and administrative			186,154				156,940					111,854					97,187				14,667				68,868				50,576
Transaction expense			—				—					10,941					4,000				6,941				—				—
Phantom stock compensation			—				—					—					—				—				24,200				—
Depreciation and amortization			16,220				10,154					7,305					6,990				315				3,210				2,361
Impairment of intangible assets			4,537				—					—					—				—				—				—
Interest expense			7,466				8,695					14,511					14,469				42				214				256
Total operating expenses			1,440,370				1,184,315					804,790					691,982				112,808				559,867				344,725
Equity in earnings of unconsolidated affiliates			357				309					282					282				—				234				2,058
Income before minority interest and income taxes			134,755				124,950					52,255					45,673				6,582				39,782				29,996
Minority interest			—				(303	)				(3,227	)				(1,979	)			(1,248	)			(6,272	)			(5,519	)
Income before income taxes			134,755				124,647					49,028					43,694				5,334				33,510				24,477
Income tax expense			(48,295	)			(43,811	)				(19,772	)				(17,144	)			(2,628	)			(9,193	)			(5,417	)
Net income			86,460				80,836					29,256					26,550				2,706				24,317				19,060
Preferred dividends			—				(2,021	)				(15,607	)				(15,607	)			—				—				—
Net income available to common stockholders and members		$	86,460			$	78,815				$	13,649				$	10,943			$	2,706			$	24,317			$	19,060
Net income per unit:
Basic			—				—					—					—			$	0.55			$	5.31			$	4.67
Diluted			—				—					—					—			$	0.55			$	5.31			$	4.67
Weighted average units outstanding:
Basic			—				—					—					—				4,884,176				4,578,176				4,078,176
Diluted			—				—					—					—				4,884,176				4,578,176				4,078,176
Net income per common share available to common stockholders:
Basic		$	1.51			$	1.44				$	—				$	0.34			$	—			$	—			$	—
Diluted		$	1.51			$	1.44					—				$	0.34				—				—				—
Weighted average common shares outstanding:
Basic			57,249,252				54,617,744					—					32,173,707				—				—				—
Diluted			57,348,196				54,720,373					—					32,215,288				—				—				—
Cash Flow Data:
Capital expenditures		$	15,886			$	7,177				$	2,802				$	2,653			$	149			$	2,512			$	3,198
Cash provided by (used in):
Operating activities			72,752				167,621					72,103					57,139				14,964				24,665				63,392
Investing activities			(389,195	)			(336	)				(276,346	)				(270,877	)(6)			(5,469	)			(34,615	)			42,647
Financing activities			302,090				61,073					322,935					323,823	(6)			(888	)			(23,311	)			(11,750	)
		(dollars in thousands)
Balance Sheet Data (at period end):
Cash and cash equivalents		$	324,090			$	338,443				$	110,085				$	110,085			$	76,441			$	67,834			$	101,095
Total assets			1,351,073				842,645					591,838					591,838				157,350				142,674				132,420
Total long-term debt, including current maturities			296,250				—					188,526					188,526				5,358				5,475				6,175
Stockholders’/members’ equity			671,355				575,282					260,544					260,544				58,131				55,435				22,969
Operating Statistics:
Medical loss ratio — Medicare Advantage (7)			79.7	%			78.8	%				78.4	%				78.3	%			78.7	%			78.1	%			78.1	%
Medical loss ratio — Commercial (7)			82.9	%			89.8	%				84.4	%				85.5	%			78.8	%			85.3	%			86.2	%
Medical loss ratio — PDP (7)			86.3	%			73.4	%				—					—				—				—				—
Selling, general and administrative expense ratio(8)			11.8	%			12.0	%				13.1	%				13.2	%			12.3	%			11.5	%			13.6	%
Members — Medicare Advantage (9)			153,197				115,132					101,281					101,281				69,236				63,792				47,899
Members — Commercial (9)			11,801				31,970					41,769					41,769				40,523				48,380				54,280
Members — PDP(9)			139,212				88,753					—					—				—				—				—

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

     The following discussion and analysis of financial condition and results of operations should be read in conjunction with our audited consolidated financial statements, the notes to our audited consolidated financial statements, and the other financial information appearing elsewhere in this report. We intend for this discussion to provide you with information that will assist you in understanding our financial statements, the changes in certain key items in those financial statements from year to year, and the primary factors that accounted for those changes. It includes the following sections:

	•		Overview;
	•		Results of Operations;
	•		Liquidity and Capital Resources;
	•		Off-Balance Sheet Arrangements;
	•		Critical Accounting Policies and Estimates; and
	•		Recent Accounting Pronouncements.

     This discussion contains forward-looking statements based on our current expectations that by their nature involve risks and uncertainties. Our actual results and the timing of selected events could differ materially from those anticipated in these forward-looking statements. Moreover, past financial and operating performance are not necessarily reliable indicators of future performance and you are cautioned in using our historical results to anticipate future results or to predict future trends. In evaluating any forward-looking statement, you should specifically consider the information set forth under the caption “Special Note Regarding Forward-Looking Statements” and in “Item 1A. Risk Factors,” as well as other cautionary statements contained elsewhere in this report, including the matters discussed in “Critical Accounting Policies and Estimates” below.

Overview

     HealthSpring, Inc. (the “company” or “HealthSpring”) is a managed care organization whose primary focus is Medicare, the federal government-sponsored health insurance program for U.S. citizens aged 65 and older, qualifying disabled persons, and persons suffering from end-stage renal disease.

     We operate Medicare Advantage plans in Alabama, Florida, Illinois, Mississippi, Tennessee and Texas and offer Medicare Part D prescription drug plans to persons in all 50 states. We sometimes refer to our Medicare Advantage plans (including plans providing prescription drug benefits, or MA-PD) collectively as “Medicare Advantage” plans and our stand-alone prescription drug plan as our “PDP.” For purposes of additional analysis, the company provides membership and certain financial information, including premium revenue and medical expense, for our Medicare Advantage (including MA-PD) and PDP plans. Although we concentrate on Medicare plans, we also utilize our infrastructure and provider networks in Alabama and Tennessee to offer commercial health plans to employer groups.

2007 Highlights

	•		We acquired LMC Health Plans, which had approximately 25,800 members at the date of acquisition on October 1, 2007.
	•		Organic Medicare Advantage membership in 2007 increased 10.5% over the prior year.
	•		Effective January 1, 2007, we began operation as a national PDP plan.
	•		Our diluted EPS was $1.51 for 2007 compared with $1.44 for 2006.
	•		Medicare premium revenue for 2007 was $1.5 billion; an increase of 28.7% over 2006 results.
	•		Medicare Advantage (including MA-PD) premiums were $1.4 billion for 2007, reflecting an increase of 30.1% over the prior year. Stand-alone PDP premiums increased $14.6 million, or 14.4%, to $116.0 million in 2007.
	•		Total cash and cash equivalents at December 31, 2007 was $324.1 million, including cash of $36.2 million held at unregulated subsidiaries.

Acquisition of Leon Medical Centers Health Plans

     On October 1, 2007, we completed the acquisition of all of the outstanding capital stock of LMC Health Plans pursuant to the terms of a Stock Purchase Agreement, dated as of August 9, 2007 (the “Stock Purchase Agreement”). LMC Health Plans is a Miami, Florida-based Medicare Advantage HMO with approximately 26,000 members. Pursuant to the Stock Purchase Agreement, we acquired LMC Health Plans for $355.0 million in cash and contingent consideration of 2,666,667 shares of HealthSpring common stock, which share consideration has been deposited in escrow and will be released to the former stockholders of LMC Health Plans if Leon Medical Centers, Inc. (“LMC”) completes the construction of two additional medical centers in accordance with the timetable set forth in the purchase agreement. As part of the transaction, we entered into an exclusive long-term provider contract (“the “Leon Medical Services Agreement”) with LMC. LMC operates five Medicare-only medical clinics located in Miami-Dade County and has a ten-year history of providing medical care and customer service to the Hispanic Medicare-eligible community of South Florida. The Leon Medical Services Agreement is for an initial term of approximately ten years with an additional five-year renewal term at our option.

     Payments for medical services under the Leon Medical Services Agreement are based on agreed upon rates for each service, multiplied by the number of plan members as of the first day of each month. There is a sharing arrangement with regard to LMC Health Plans’ annual medical loss ratio (“MLR”) whereby the parties share equally any surplus or deficit of up to 5% with regard to agreed-upon MLR benchmarks. The initial target for the annual MLR is 80.0%, which increases to 81.0% during the term of the agreement.

     LMC Health Plans has agreed that, during the term of the agreement, LMC will be LMC Health Plans’ exclusive clinic-model provider, as defined in the agreement, in the four South Florida counties of Miami-Dade, Palm Beach, Broward, and Monroe. LMC has agreed that LMC Health Plans will be, during the term of the agreement, the exclusive health maintenance organization to whom LMC provides medical services as contemplated by the agreement in the four-county area.

Basis of Presentation

Public Offerings

     In February 2006, we completed our initial public offering, or IPO, of common stock. In the IPO, we issued 10.6 million shares of common stock at a price of $19.50 per share. We used the net proceeds of the IPO of approximately $188.6 million to repay all of our outstanding indebtedness, including accrued and unpaid interest and other expenses related to the IPO. In connection with the IPO, the minority interests in our Texas HMO subsidiary were exchanged for 2,040,194 shares of common stock. In addition, as a result of the IPO, all of our outstanding shares of preferred stock and accrued but unpaid dividends automatically converted into shares of common stock at the IPO price.

     On October 10, 2006, we completed a secondary public offering of our common stock. In connection with the secondary offering certain stockholders of the company, including funds affiliated with GTCR Golder Rauner, LLC, or the GTCR Funds, sold 11,600,000 shares of common stock at a price of $18.98 per share. We did not receive any proceeds from the sale of the shares in the secondary offering.

The Recapitalization

     HealthSpring, Inc. was formed in October 2004 in connection with a recapitalization transaction, which was accounted for using the purchase method, involving our predecessor, NewQuest, LLC, its members, the GTCR Funds, and certain other investors and lenders. The recapitalization was completed on March 1, 2005.

     Prior to the recapitalization, approximately 15% of the ownership interests in two of our Tennessee management subsidiaries and approximately 27% of the membership interests of our Texas HMO subsidiary, Texas HealthSpring, LLC, were owned by outside investors. Contemporaneously with the recapitalization, we purchased all of the minority interests in our Tennessee subsidiaries and a portion of the membership interests held by the minority investors in Texas HealthSpring, LLC. Following the purchase, the outside investors in Texas HealthSpring, LLC owned an approximately 9% ownership interest. Following a private placement in June 2005, and as of December 31, 2005, the outside investors owned an approximately 15.9% interest in Texas HealthSpring,

LLC, which interest was automatically exchanged, without additional consideration, for 2,040,194 shares of our common stock immediately prior to the IPO.

     For purposes of comparing our 2005 twelve-month results with the comparable 2007 and 2006 periods, we have combined the results of operations of the predecessor from January 1, 2005 through February 28, 2005 and of the company for the period from March 1, 2005 through December 31, 2005. This combined presentation is not in accordance with GAAP; however, we believe it is useful in analyzing and comparing certain of our operating trends for the last three fiscal years. The combined and consolidated results of operations include the accounts of HealthSpring, Inc. and all of its subsidiaries. Significant intercompany accounts and transactions have been eliminated.

Revenue

     General. Our revenue consists primarily of (i) premium revenue we generate from our Medicare and commercial lines of business; (ii) fee revenue we receive for management and administrative services provided to independent physician associations, health plans, and self-insured employers, and for access to our provider networks; and (iii) investment income.

     Premium Revenue. Our Medicare and commercial lines of business include all premium revenue we receive in our health plans. Our Medicare contracts entitle us to premium payments from CMS, on behalf of each Medicare beneficiary enrolled in our plans, generally on a per member per month, or PMPM, basis. In our commercial HMOs, we receive a monthly payment from or on behalf of each enrolled member. In both our commercial and Medicare plans, we recognize premium revenue during the month in which the company is obligated to provide services to an enrolled member. Premiums we receive in advance of that date are recorded as deferred revenue.

     Premiums for our Medicare and commercial products are generally fixed by contract in advance of the period during which health care is covered. Each of our Medicare plans submits rate proposals to CMS, generally by county or service area, in June for each Medicare product that will be offered beginning January 1 of the subsequent year. Retroactive rate adjustments are made periodically with respect to each of our Medicare plans based on the aggregate health status and risk scores of our plan populations. For a further explanation of the company’s accounting for retroactive risk payments, see “—Risk Adjustment Payments” section below. Our commercial premium rates are generally fixed for the plan year, in most cases beginning January 1.

     As with our traditional Medicare Advantage plans, we provide written bids to CMS for our Part D plans, which include the estimated costs of providing prescription drug benefits over the plan year. Premium payments from CMS are based on these estimated costs. The amount of CMS payments relating to the Part D standard coverage for our MA-PD and PDP plan is subject to adjustment, positive or negative, based upon the application of risk corridors that compare our prescription drug costs in our bids to CMS to our actual prescription drug costs. Variances exceeding certain thresholds may result in CMS making additional payments to us or our refunding to CMS a portion of the premium payments we previously received. We estimate and recognize adjustments to premium revenue related to estimated risk corridor payments as of each quarter end based upon our actual prescription drug costs for each reporting period as if the annual contract were to end at the end of each reporting period. We account for estimated risk corridor settlements with CMS on our balance sheet and as an operating activity in our statement of cash flows. Actual risk corridor payments upon final settlement with CMS could differ materially, favorably or unfavorably, from our estimates.

     Because of the Part D product benefit design, the company incurs prescription drug costs unevenly throughout the year, resulting in fluctuations in quarterly MA-PD and PDP earnings. As a result of product features such as co-payments and deductibles, the coverage gap, risk corridors, and reinsurance, we incur a disproportionate amount of prescription drug costs in the first half of the year. As a result, our Part D-related earnings increase in the second half of the year as compared to the first half of the year.

     Certain Part D-related payments we receive from CMS represent payments for claims that we pay on behalf of CMS for which we assume no risk. We account for these payments as funds held for the benefit of members on our balance sheet and as a financing activity in our statement of cash flows. We do not recognize premium revenue or claims expense for these payments as these amounts represent pass-through payments from CMS to fund deductibles, co-payments, and other member benefits.

     We recognize prescription drug costs as incurred, net of rebates from drug companies.

     Fee Revenue. Fee revenue primarily includes amounts paid to us for management services provided to independent physician associations and health plans. Our management subsidiaries typically generate fee revenue on one of three bases: (1) as a percentage of revenue collected by the relevant health plan; (2) as a fixed PMPM payment or percentage of revenue for members serviced by the relevant independent physician association; or (3) as fees we receive for offering access to our provider networks and for administrative services we offer to self-insured employers. Fee revenue is recognized in the month in which services are provided. In addition, pursuant to certain of our management agreements with independent physician associations, or IPA’s, we receive fees based on a share of the profits of the independent physician associations. To the extent these fees relate to members of our HMO subsidiaries, the fees are recognized as a credit to medical expense. Management fees calculated based on profits are recognized, as fee revenue or as a credit to medical expenses, if applicable, when we can readily determine that such fees have been earned, which determination is typically made on a monthly basis.

     Investment Income. Investment income consists of interest income and gross realized gains and losses from sales of available-for-sale investments and discount amortization and interest on held-to-maturity securities.

Medical Expense

     Our largest expense is the cost of medical services we arrange for our members, or medical expense. Medical expense for our Medicare and commercial plans primarily consist of payments to physicians, hospitals, pharmacies, and other health care providers for services and products provided to our Medicare and commercial members. We generally pay our providers on one of three bases: (1) fee-for-service contracts based on negotiated fee schedules; (2) capitated arrangements, generally on a fixed PMPM payment basis, whereby the provider generally assumes some or all of the medical expense risk; and (3) risk-sharing arrangements, whereby we advance a capitated PMPM amount and share the risk of the medical costs of our members with the provider based on actual experience as measured against pre-determined sharing ratios. Pharmacy cost represents payments for members’ prescription drug benefits, net of rebates from drug manufacturers. Rebates are recognized when earned, according to the contractual arrangements with the respective manufacturers.

     One of our primary tools for managing our business and measuring our profitability is our medical loss ratio, or MLR, the ratio of our medical expenses to the premiums we receive. Relatively small changes in the ratio of our medical expenses relative to the premium we receive can result in significant changes in our financial results. Changes in the MLR from period to period result from, among other things, changes in Medicare funding or commercial premiums, changes in benefits offered by our plans, our ability to manage medical expense, changes in accounting estimates related to incurred but not reported, or IBNR, claims, and our Part-D-related earnings relative to CMS’ risk corridors. We use MLRs both to monitor our management of medical expenses and to make various business decisions, including what plans or benefits to offer, what geographic areas to enter or exit, and our selection of healthcare providers. We analyze and evaluate our Medicare Advantage, PDP and commercial MLRs separately.

Results of Operations

Percentage Comparisons

     The following table sets forth the consolidated and combined statements of income data expressed in dollars (in thousands) and as a percentage of revenues for each period indicated.

		Year Ended December 31,
		2007								2006								2005 (combined)
Revenue:
Premium:
Medicare premiums		$	1,479,576				93.9	%		$	1,149,844				87.9	%		$	705,677				82.4	%
Commercial premiums			46,648				3.0				120,504				9.2				126,872				14.8
Total premium revenue			1,526,224				96.9				1,270,348				97.1				832,549				97.2
Management and other fees			24,601				1.6				26,688				2.0				20,416				2.4
Investment income			23,943				1.5				11,920				0.9				3,798				0.4
Total Revenue			1,574,768				100.0				1,308,956				100.0				856,763				100.0
Operating expenses:
Medical expense:
Medicare expense		$	1,187,331				75.4				900,358				68.7				553,084				64.5
Commercial expense			38,662				2.5				108,168				8.3				107,095				12.5
Total medical expense			1,225,993				77.9				1,008,526				77.0				660,179				77.0
Selling, general and administrative			186,154				11.8				156,940				12.0				122,795				14.4
Depreciation and amortization			16,220				1.0				10,154				0.8				7,305				0.8
Impairment of intangible assets			4,537				0.3				—				—				—				—
Interest expense			7,466				0.5				8,695				0.7				14,511				1.7
Total operating expenses			1,440,370				91.5				1,184,315				90.5				804,790				93.9
Income before equity in earnings of unconsolidated affiliates, minority interest and income taxes			134,398				8.5				124,641				9.5				51,973				6.1
Equity in earnings of unconsolidated affiliates			357				0.1				309				—				282				—
Income before minority interest and income taxes			134,755				8.6				124,950				9.5				52,255				6.1
Minority interest			—				—				(303	)			—				(3,227	)			(0.4	)
Income before income taxes			134,755				8.6				124,647				9.5				49,028				5.7
Income tax expense			(48,295	)			(3.1	)			(43,811	)			(3.3	)			(19,772	)			(2.3	)
Net income			86,460				5.5				80,836				6.2				29,256				3.4
Preferred dividends			—				—				(2,021	)			(0.2	)			(15,607	)			(1.8	)
Net income available to common stockholders or members		$	86,460				5.5	%		$	78,815				6.0	%		$	13,649				1.6	%

Membership

     Our primary source of revenue is monthly premium payments we receive based on membership enrolled in our managed care plans. The following table summarizes our Medicare Advantage (including MA-PD), stand-alone PDP, and commercial plan membership, by state, as of the dates indicated.

		December 31,
		2007				2006				2005
Medicare Advantage Membership
Tennessee			50,510				46,261				42,509
Texas			36,661				34,638				29,706
Alabama			30,600				27,307				24,531
Florida(1)			25,946				—				—
Illinois			8,639				6,284				4,166
Mississippi			841				642				369
Total			153,197				115,132				101,281
Medicare Stand-Alone PDP Membership			139,212				88,753				—
Commercial Membership(2)
Tennessee			11,046				29,341				29,859
Alabama			755				2,629				11,910
Total(3)			11,801				31,970				41,769

     Medicare Advantage. Our Medicare Advantage membership increased by 33.1% to 153,197 members at December 31, 2007 as compared to 115,132 members at December 31, 2006. The increase was principally attributable to the addition of 25,946 members as a result of the acquisition of LMC Health Plans and to 10.5% organic growth in membership in our existing core markets through increased penetration in existing service areas. Medicare Advantage (including MA-PD) membership as of January 1, 2008 was 151,671 reflecting decreases in two of our markets as a result of exiting certain poorer performing counties and discontinuing certain product offerings.

     Stand-Alone PDP. Stand-alone PDP membership increased by 56.9% to 139,212 at December 31, 2007 as compared to 88,753 members at December 31, 2006. The increase was principally attributable to additional auto-assignment by CMS of membership. In 2006, we offered prescription drug benefits to our Medicare Advantage plan members. Effective January 1, 2007, we began operations as a national PDP plan. PDP membership as of January 1, 2008 was approximately 254,000 as a result of an additional auto-assignment by CMS of membership in the California and New York regions effective as of the start of the year. We expect monthly increases to PDP membership throughout 2008 as a result of additional auto-assignments from CMS. We do not actively market our PDP and have relied for membership on CMS auto-assignments of dual-eligible beneficiaries.

     Commercial. Our commercial HMO membership declined from 31,970 members at December 31, 2006 to 11,801 members at December 31, 2007, or by 63.1%, primarily as a result of the non-renewal by employers in Alabama and Tennessee. Total commercial membership as of January 1, 2008 was 3,418.

Risk Adjustment Payments

     Our Medicare premium revenue is subject to adjustment based on the health risk of our members under CMS’s risk adjustment payment methodology. Under the risk adjustment payment methodology, managed care plans must capture, collect, and report diagnosis code information to CMS. After

reviewing the respective submissions, CMS establishes the payments to Medicare plans generally at the beginning of the calendar year, and then adjusts premium levels on two separate occasions on a retroactive basis. The first retroactive risk premium adjustment for a given fiscal year generally occurs during the third quarter of such fiscal year. This initial settlement (the “Initial CMS Settlement”) represents the updating of risk scores for the current year based on the prior year’s dates of service. CMS then issues a final retroactive risk premium adjustment settlement for the fiscal year in the following year (the “Final CMS Settlement”). During 2006, we were unable to estimate the impact of either of these risk adjustment settlements, and as such recorded them upon notification from CMS of such amounts. In the first quarter of 2007, we began estimating and recording on a monthly basis the Initial CMS Settlement, as we concluded we had the ability to reasonably estimate such amounts. Similarly in the fourth quarter of 2007 the company accrued for the estimated 2007 Final CMS Settlement as such amount was reasonably estimable. The Final CMS Settlement for 2006 was recorded during the second quarter of 2007 when payment notification was received from CMS. As of January 2008, we will estimate and record on a monthly basis both the Initial CMS Settlement and the Final CMS Settlement for the 2008 CMS plan year. All such estimated amounts are periodically updated as necessary as additional diagnoses code information is reported to CMS and adjusted to actual amounts when the ultimate adjustment settlements are either received from CMS or we receive notification from CMS of such settlement amounts.

     The following schedule includes premiums, medical costs, and medical loss ratio statistics as adjusted for the following items:

	•		Adjustments to reflect in 2006 the 2006 final risk-adjustment payment from CMS of $14.8 million and the related risk-sharing costs, which were recorded in 2007 results.
	•		Adjustments to reflect in 2005 the 2005 final payment from CMS of $5.7 million and related risk-sharing costs, which were recorded in 2006 results.
	•		Adjustments to exclude from 2005 results the 2004 final payment from CMS of $1.6 million and related risk-sharing costs, which were recorded in 2005, as such amounts related to fiscal 2004.

     The following schedule is included herein to assist in understanding our operating results for the respective periods. Medicare Advantage premiums and medical costs include amounts for both MA-only and MA-PD.

		Year Ended December 31,
Unaudited, $ in Millions		2007				2006				2005
Medicare Advantage Premiums — as reported		$	1,363.6			$	1,048.5			$	705.7
Pro-forma adjustments:
2006 CMS Final Risk Adjustment Payment			(14.8	)			14.8				—
2005 CMS Final Risk Adjustment Payment			—				(5.7	)			5.7
2004 CMS Final Risk Adjustment Payment			—				—				(1.6	)
Medical Advantage Premiums — as adjusted		$	1,348.8			$	1,057.6			$	709.8
Medicare Advantage Medical Cost — as reported		$	1,087.2			$	825.9			$	553.1
Pro-forma adjustments:
2006 CMS Final Risk Adjustment Payment			(3.5	)			3.5				—
2005 CMS Final Risk Adjustment Payment			—				(0.9	)			0.9
2004 CMS Final Risk Adjustment Payment			—				—				(0.3	)
Medical Advantage Medical Costs — as adjusted			1,083.7			$	828.5			$	553.7
Medical Loss Ratios (MLRs):
Total Medical Costs — as reported			79.7	%			78.8	%			78.4	%
Total Medical Costs — as adjusted			80.3	%			78.3	%			78.0	%

     Because we did not estimate and accrue for the risk adjustment payments in the manner assumed in the pro-forma table, this pro-forma presentation is not in accordance with Generally Accepted Accounting Principles in the United States (GAAP). We believe that these non-GAAP measures are useful to investors and management in analyzing financial trends regarding our operating and financial performance. These non-GAAP measures should be considered in addition to, but not as a substitute for, the corresponding GAAP items shown in the table above.

Settlement of 2006 Part D Activity

     In October 2007, we received notification from CMS that our obligation to CMS to settle all Part D activity for the 2006 plan year totaled $103.7 million. We settled such amounts from 2006 with CMS in the fourth quarter of 2007. As a result of adjusting our estimate of amounts due CMS for the 2006 plan year to amounts set forth in the final settlement notification from CMS, there was a negative impact on operations in the three months ended September 30, 2007 of $3.5 million.

Comparison of the Year Ended December 31, 2007 to the Year Ended December 31, 2006

Revenue

     Total revenue was $1,574.8 million in the year ended December 31, 2007 as compared with $1,309.0 million for the same period in 2006, representing an increase of $265.8 million, or 20.3%. The components of revenue were as follows:

     Premium Revenue: Total premium revenue for 2007 was $1,526.2 million as compared with $1,270.3 million in the same period in 2006, representing an increase of $255.9 million, or 20.1%. The components of premium revenue and the primary reasons for changes were as follows:

     Medicare Advantage: On an as-adjusted basis (see “Risk Adjustment Payments” table above), Medicare Advantage premiums were $1,348.8 million for year ended December 31, 2007 versus $1,057.6 million in the same period in 2006, representing an increase of $291.2 million, or 27.5%. The increase in Medicare Advantage premiums in 2007 is attributable to increases in membership (which we measure in membership months) and PMPM premium rates. Member months increased 20.9% for the 2007 period as compared to the 2006 period. PMPM premiums increased 5.5% to $858.78 for 2007 from $814.08 for 2006 (as adjusted to exclude the effect of the retroactive risk payments related to prior periods) as a result of the inclusion of the LMC Health Plans’ higher PMPM premiums from the date of acquisition in October 2007 and as a result of increases in rates as affected by risk scores and the mix of members qualifying as dual-eligibles. The inclusion of LMC Health Plans’ results since the date of acquisition in October 2007 contributed 140 basis points of the 2007 PMPM increase as compared to 2006 PMPMs. As reported, Medicare Advantage premiums were $1,363.6 million for the year ended December 31, 2007 versus $1,048.5 million in the same period in 2006, representing an increase of $315.1 million, or 30.1%. For 2008, we expect average reimbursement rates for our Medicare Advantage plans to increase by 10% to 11% over 2007 (or 7 to 8% excluding the reimbursement rates for our Florida market).

     PDP: PDP premiums (after risk corridor adjustments) were $116.0 million in the year ended December 31, 2007 compared to $101.4 million in the same period of 2006, an increase of $14.6 million, or 14.4%. Our average PMPM premiums (after risk corridor adjustments) decreased 20.1% to $79.94 in the current period versus $100.10 during the 2006 period. The impact of the rate decrease in the current period was more than offset by a 43.2% increase in member months in the year ended December 31, 2007 as compared to the same period in 2006. We expect PMPM premiums for 2008 to be relatively unchanged compared to 2007 levels.

     Commercial: Commercial premiums were $46.6 million in the 2007 as compared with $120.5 million in the 2006 comparable period, reflecting a decrease of $73.9 million, or 61.3%. The decrease was attributable to the 63.3% decline in member months. PMPM rates for 2007 increased 5.5% compared to 2006. Because of our expansion of our Medicare program into new areas in existing markets, continuing Medicare member growth in certain of our existing service areas, the expansion of our national PDP product and the non-renewal of coverage by several large employers in Tennessee and Alabama, we expect commercial premium revenue as a percentage of total premium revenue and total revenue to continue to decline in the future.

     Fee Revenue. Fee revenue was $24.6 million in the year ended December 31, 2007 as compared with $26.7 million in the comparable period of 2006, representing a decrease of $2.1 million, or 7.8%. The decrease in the current period is primarily attributable to the termination of a management agreement on December 31, 2006, which was partially offset by increases in other fee revenue.

     Investment Income. Investment income was $23.9 million for the year ended December 31, 2007 versus $11.9 million for the comparable period of 2006, reflecting an increase of $12.0 million, or 100.9%. The increase is attributable to an increase in average invested and cash balances, coupled with a higher average yield on these balances.

Medical Expense

     Medicare Advantage. For the year ended December 31, 2007, the Medicare Advantage (including MA-PD) MLR was 80.3% versus 78.3% for the same period of 2006 on an as-adjusted basis (see “— Risk Adjustment Payments” above). The deterioration in 2007 as compared to the same period of 2006 resulted primarily from higher medical services expenses and facility charges in outpatient and emergency room settings and higher in-patient utilization. As reported, Medicare Advantage (including MA-PD) medical expense for the year ended December 31, 2007 increased $261.4 million, or 31.6%, to $1,087.3 million from $825.9 million for the comparable period of 2006, primarily as a result of the medical expense incurred by LMC Health Plans from October 1, 2007, the date we acquired the health plan, and as a result of increased membership and utilization in our existing health plans.

     Our Medicare Advantage (including MA-PD) medical expense calculated on a PMPM basis was $690.03 for the year ended December 31, 2007, compared with $637.77 for the 2006 period (adjusted to exclude the portion of risk sharing with providers associated with retroactive risk payments relating to prior periods, net (see “— Risk Adjustment Payments” above)), reflecting an increase of 8.2%, primarily as a result of the factors discussed previously regarding the deterioration in the MLR during 2007 along with medical cost inflation.

     PDP. PDP medical expense for the year ended December 31, 2007 increased $25.6 million or 34.4% to $100.0 million, compared to $74.4 million in the same period last year. PDP MLR for the 2007 period equaled 86.3% compared to 73.4% in the 2006 period. The change in the current period 2007 MLR compared to the 2006 period was primarily a function of the decrease in PMPM PDP revenue in 2007 as compared to 2006 and the impact of changes in estimates as a result of the settlement with CMS for 2006 Part D activity. The final settlement with CMS for the 2006 plan year had a negative impact of 110 basis points on the 2007 PDP MLR.

     Commercial. Commercial medical expense decreased by $69.5 million, or 64.3%, to $38.7 million in 2007 as compared to $108.2 million for the same period of 2006. The decrease in the current period was primarily attributable to the reduction in membership versus the prior year period. The commercial MLR was 82.9% for 2007 as compared with 89.8% in 2006. The improvement in the MLR in 2007 was primarily the result of several large employer groups with historically higher medical loss experience not renewing for 2007.

Selling, General, and Administrative Expense

     Selling, General and Administrative, or SG&A, expense for 2007 was $186.2 million as compared with $156.9 million for 2006, an increase of $29.2 million, or 18.6%. As a percentage of revenue, SG&A expense was 11.8% for 2007 as compared with 12.0% for the prior year. This decrease in SG&A expense as a percentage of revenue was attributable primarily to the inclusion of LMC Health Plans since October 1, 2007, the date of acquisition. This was offset by higher than anticipated SG&A expense for 2007 in our existing health plans as a result of increases in personnel and related costs and printing and postage costs associated primarily with increases in PDP membership.

Depreciation and Amortization Expense

     Depreciation and amortization expense was $16.2 million in 2007 as compared with $10.2 million in 2006, representing an increase of $6.0 million, or 59.7%. The increase in the current period was the result of $3.3 million in amortization expense associated with intangible assets recorded as part of the acquisition of LMC Health Plans and incremental depreciation on property and equipment additions made in 2006 and 2007. The company expects amortization of the LMC Health Plan intangible assets in 2008 to be approximately $13.0 million.

Impairment of Intangible Assets

     During the second quarter of 2007, the company recorded a $4.5 million charge for the impairment of intangible assets associated with commercial customer relationships in the company’s Tennessee health plan. This second quarter charge was the result of the company’s expectation that significant declines in commercial membership would occur as a result of its decision in the second quarter of 2007 to implement premium increases upon renewal for large group plans.

Interest Expense

     Interest expense was $7.5 million in the year ended December 31, 2007 as compared with $8.7 million in 2006. Interest expense recognized in the 2007 period was the result of the company’s borrowing $300.0 million in term loans on October 1, 2007 in connection with the purchase of LMC Health Plans and the write-off of deferred financing costs of $0.7 million. We expect increases in the amount of interest expense in future periods as a result of these borrowings.

     The company’s interest expense in the 2006 period related to interest on outstanding borrowings, the write-off of deferred financing costs of $5.4 million, and an early payment premium of $1.1 million related to the payoff of all the company’s outstanding indebtedness and related accrued interest in February 2006 with proceeds from the IPO.

Income Tax Expense

     For 2007, income tax expense was $48.3 million, reflecting an effective tax rate of 35.8%, versus $43.8 million, reflecting an effective tax rate of 35.1%, for 2006. The lower tax rate in 2006 reflects changes in estimates resulting from the completion of the 2005 consolidated federal tax return and state tax planning.

Preferred Dividends

     In 2006, the company accrued $2.0 million of dividends payable on preferred stock. In February 2006, in connection with the IPO, the preferred stock and all accrued and unpaid dividends were converted into common stock.

Comparison of the Year Ended December 31, 2006 to the Combined Twelve-Month Period Ended December 31, 2005

Revenue

     Total revenue was $1,309.0 million for 2006 as compared with $856.8 million in the combined twelve months of 2005, representing an increase of $452.2 million, or 52.8%. The components of revenue were as follows:

     Premium Revenue: Total premium revenue for the year ended December 31, 2006 was $1,270.3 million as compared with $832.5 million in the combined twelve months of 2005, representing an increase of $437.8 million, or 52.6%. The components of premium revenue and the primary reasons for changes were as follows:

     Medicare Advantage: On an as-adjusted basis (see “Risk Adjustment Payments” table above), Medicare Advantage (including MA-PD) premiums were $1,057.6 million for 2006 versus $709.8 million in the prior year, representing an increase of $347.8 million, or 49.0%. The increase in Medicare Advantage (including MA-PD) premiums in 2006 is attributable to increases in membership and PMPM premium rates and the addition of Part D premiums. Membership months increased 30.4% for 2006 as compared to 2005. PMPM premiums (as adjusted to exclude the effect of the retroactive risk payments related to prior periods) increased 14.3% to $814.06 for 2006 from $712.43 for 2005, primarily as a result of additional PMPM premium relating to the Part D benefit received by MA-PD members beginning January 1, 2006. On a similarly adjusted basis, our Medicare Advantage premiums (excluding the Part D-related premium under MA-PD) calculated on a PMPM basis was $744.49 for 2006, compared with $712.43 for 2005, reflecting an increase of 4.5% primarily as a result of increases in rates and risk scores and the mix of our members qualifying as dual-eligibles. As reported, Medicare Advantage (including MA-PD) premiums were $1,048.5 million for 2006 versus $705.7 million in the prior year representing an increase of $342.8 million or 48.6%.

     PDP: PDP premiums (after risk corridor adjustments) were $101.4 million in 2006. Our average PMPM premiums received from CMS (after risk corridor adjustments) were $100.10 for PDP members for 2006. Because the Medicare Part D program was implemented effective January 1, 2006, there are no comparable PDP operating or financial results for 2005.

     Commercial: Commercial premiums were $120.5 million in 2006 as compared with $126.9 million in the combined twelve months of 2005, reflecting a decrease of $6.4 million, or 5.0%. The decrease was attributable to the decline in membership, which was partially offset by average commercial premium increases of approximately 7.4%.

     Fee Revenue: Fee revenue was $26.7 million in 2006 as compared with $20.4 million in the combined twelve months of 2005, representing an increase of $6.3 million, or 30.7%. Of the increase, $4.3 million was attributable to the addition of a management agreement, which was terminated as of December 31, 2006. The remaining increase resulted from increased member volumes in the IPAs managed by the company.

     Investment Income: Investment income was $11.9 million for 2006 versus $3.8 million for the combined twelve months of 2005, reflecting an increase of $8.1 million, or 213.9%. The increase is attributable to an increase in average invested and cash balances, coupled with a higher average yield on these balances.

Medical Expense

     Medicare Advantage. Medicare Advantage (including MA-PD) medical expense for 2006 increased $272.8 million, or 49.3%, to $825.9 million from $553.1 million for the combined twelve months of 2005, primarily as a result of increased membership, increasing medical costs, and Part D prescription drug coverage for MA-PD members beginning January 1, 2006. For 2006, Medicare Advantage (including MA-PD) MLR was 78.8% versus 78.4% for 2005. Our Medicare Advantage (including MA-PD) medical expense calculated on a PMPM basis was $635.77 for 2006, compared with $555.14 for 2005, reflecting an increase of 14.6%. The primary driver of the increase in 2006 PMPM expense is the additional expense resulting from the Part D prescription drug benefit effective as of January 1, 2006. Our Medicare Advantage medical expense (excluding MA-PD) calculated on a PMPM basis was $576.73 for 2006, compared with $555.14 for 2005, reflecting an increase of 3.9%.

     PDP. PDP medical expense for 2006 was $74.4 million reflecting an MLR of 73.4%. PDP medical expense on a PMPM basis for 2006 was $73.50.

     Commercial. Commercial medical expense increased by $1.1 million, or 1.0%, to $108.2 million for 2006 as compared to $107.1 million for the combined twelve months of 2005. The commercial MLR was 89.8% for 2006 as compared with 84.4% in 2005, an increase of 540 basis points, which was primarily attributable to an unusually large number of high dollar in-patient cases during 2006.

Selling, General, and Administrative Expense

     SG&A expense for 2006 was $156.9 million as compared with $111.9 million (not including $10.9 million of transaction expense incurred in conjunction with the recapitalization) for the prior year, an increase of $45.0 million, or 40.3%. As a percentage of revenue, SG&A expense was 12.0% for 2006 as compared with 13.0% (as adjusted) for the prior year.

     The increase in SG&A expense was attributable to an increase in personnel and related costs, including increases of $15.9 million associated with supporting and sustaining our membership growth and in corporate personnel, $9.4 million associated with the implementation of Part D and our operations related thereto, stock compensation expense totaling $5.3 million recorded in connection with the adoption of SFAS No. 123R and incremental advertising and selling costs of $3.7 million. The remaining increase is due to public company and other corporate costs, including expenses related to compliance with the Sarbanes-Oxley Act of 2002.

Depreciation and Amortization Expense

     Depreciation and amortization expense was $10.2 million in 2006 as compared with $7.3 million in the combined twelve months of 2005, representing an increase of $2.9 million, or 39.0%. The increase is primarily attributable to the amortization of identifiable intangible assets recorded in conjunction with the recapitalization in 2005. Amortization of $7.5 million was recorded during 2006 as compared with $5.0 million 2005. Amortization in 2006 includes approximately $1.7 million as a result of the accelerated amortization of recorded intangibles for customer relationships in Alabama, as a result of decreases in membership.

Interest Expense

     Interest expense was $8.7 million in 2006 as compared with $14.5 million in the combined twelve months of 2005. Most of the company’s interest expense in 2006 related to the write-off of deferred financing costs in the amount of $5.4 million and a prepayment premium of $1.1 million related to the payoff of all the company’s

outstanding indebtedness and related accrued interest with proceeds from the IPO. Interest expense in 2005 related primarily to the company’s indebtedness incurred in connection with the recapitalization.

Minority Interest

     Minority interest was $0.3 million in 2006 as compared with $3.2 million in the combined twelve months of 2005. The change is attributable to minority interest ownership in our Tennessee HMO and management subsidiaries and a higher minority interest ownership in our Texas HMO subsidiary for the two months of 2005 prior to the recapitalization. Contemporaneously with the recapitalization, we purchased all of the minority interests in the Tennessee subsidiaries. In conjunction with the IPO in February 2006, all minority interest ownership in the Texas HMO subsidiary was exchanged for company common stock.

Income Tax Expense

     For 2006, income tax expense was $43.8 million, reflecting an effective tax rate of 35.1%, versus $19.8 million, reflecting an effective tax rate of 40.3%, for the combined twelve months of 2005. The higher effective tax rate in 2005 was the result of losses at several of our subsidiaries, which were consolidated for accounting purposes, but not for tax purposes because such subsidiaries were pass-through entities prior to the recapitalization. Additionally, the lower tax rate in 2006 reflects changes in estimates identified upon the completion of the 2005 consolidated federal tax return, and state tax planning.

Preferred Dividend

     In 2006, the company accrued $2.0 million of dividends payable on the preferred stock issued in connection with the recapitalization as compared to a dividend accrued in the same combined period in 2005 of $15.6 million for the ten months following the recapitalization. In February 2006, in connection with the IPO, the preferred stock and all accrued and unpaid dividends were converted into common stock.

Liquidity and Capital Resources

     We finance our operations primarily through internally generated funds. All of our outstanding funded indebtedness was incurred in connection with the acquisition of the LMC Health Plans in October 2007. See “—Indebtedness” below.

     We generate cash primarily from premium revenue and our primary use of cash is the payment of medical and SG&A expenses. We anticipate that our current level of cash on hand, internally generated cash flows, and borrowings available under our new revolving credit facility will be sufficient to fund our working capital needs and anticipated capital expenditures over the next twelve months.

     The reported changes in cash and cash equivalents for the years ended December 31, 2007, 2006 and 2005, are summarized below:

		Year Ended December 31,
		2007				2006				2005
(in thousands)										(combined)
Net cash provided by operating activities		$	72,752			$	167,621			$	72,103
Net cash used in investing activities			(389,195	)			(336	)			(276,346	)
Net cash provided by financing activities			302,090				61,073				322,935
Net (decrease) increase in cash and cash equivalents		$	(14,353	)		$	228,358			$	118,692